Deutsche Bank sent a shockwave through the markets as it said in a new report that the US is headed for a “major recession” if the Fed cannot stem the tide of inflation.
“We will get a major recession,” Deutsche Bank economists wrote in a report to clients released on Tuesday, Apr. 26.
The problem, according to the bank, is that while inflation may be peaking, it will take a “long time” before it gets back down to the Fed’s goal of 2%. That suggests the central bank will raise interest rates so aggressively that it hurts the economy.
“We regard it…as highly likely that the Fed will have to step on the brakes even more firmly, and a deep recession will be needed to bring inflation to heel,” Deutsche Bank economists wrote in its report with the ominous title, “Why the coming recession will be worse than expected.”
To make its case, Deutsche Bank created an index that tracks the distance between inflation and unemployment over the past 60 years and the Fed’s stated goals for those metrics. That research, according to the bank, finds that the Fed today is “much further behind the curve” than it has been since the early 1980s, a period when extremely high inflation forced the central bank to raise interest rates to record highs, crushing the economy.
History shows the Fed has “never been able to correct” even smaller overshoots of inflation and employment “without pushing the economy into a significant recession,” Deutsche Bank said.
Given that the job market has “over-tightened” by as much as two percentage points of unemployment, the bank said, “Something stronger than a mild recession will be needed to do the job.”
However, it’s not all bad news. Deutsche Bank sees the economy rebounding by mid-2024 as the Fed reverses course in its inflation fight. Furthermore, not all economic and financial prognosticators agree with the major bank’s assessment.
For example, Goldman Sachs is a bit more “bearish.” While the investment firm concedes it will be “very challenging” to bring down high inflation and wage growth, it stresses that a recession is “not inevitable.”
“We do not need a recession but probably do need growth to slow to a somewhat below-potential pace, a path that raises recession risk,” Goldman Sachs economists wrote in its most recent report that was released the same day as the “gloom and doom” prediction of Deutsche Bank.
UBS is similarly hopeful that the economic expansion will continue despite the Fed’s shift to inflation-fighting mode.
“Inflation should ease from current levels, and we do not expect a recession from rising interest rates,” Mark Haefele, chief investment officer at UBS Global Wealth Management, wrote in a report on Monday, after the release of Deutsche Bank’s dire prediction.
Deutsche Bank said the most important factor behind its more negative view is the likelihood that inflation will remain “persistently elevated for longer than generally anticipated.”
The bank said several developments will contribute to higher-than-feared inflation, including the reversal of globalization, climate change, further supply-chain disruptions caused by the war in Ukraine and Covid lockdowns in China, and coming increases to inflation expectations that will support actual inflation.
“The scourge of inflation has returned and is here to stay,” Deutsche Bank said.