The Fed will only start cutting interest rates late next year - and the US economy will suffer a recession, a top economist predicts

wall street traders 2008
The US economy faces stubborn inflation, higher unemployment, elevated interest rates, and a shallow recession.Mike Segar/Reuters
  • Beth Ann Bovino expects stubborn inflation, a recession, and higher interest rates and unemployment.

  • The top S&P economist sees rates peaking around 5% and unemployment hitting 5.6% next year.

  • Inflation has likely peaked, and the US economy may shrink 0.1% next year, Bovino said.

US investors should steel themselves for stubborn inflation, higher unemployment, elevated interest rates, and a recession, top S&P Global Ratings economist Beth Ann Bovino has warned.

"As extremely high prices damage purchasing power and aggressive Federal Reserve policy increases borrowing costs, we continue to expect a shallow recession for the US economy in the first half of 2023," S&P's US chief economist said in her latest outlook.

Inflation in the US soared to a 40-year high of 9.1% in June, and remained at 7.7% in October, well above the Fed's yearly target of 2%. The US central bank has responded by hiking interest rates from nearly zero in March to a range of 3.75% to 4% today, but its efforts to curb price increases have raised the risk of an economic downturn.

Bovino suggested inflation has probably peaked, but it might not approach the Fed's target until late 2024. She predicts rates will top out at a range of 5% to 5.25% by the second quarter of next year, but policymakers won't cut them until roughly the fourth quarter of next year.

Historic inflation and elevated rates are squeezing households and businesses and dragging down growth, Bovino said. She expects the economy to contract by 0.1% next year, after expanding by an estimated 1.8% in 2022.

Bovino predicts a 0.8% drop in gross domestic product (GDP) from peak to trough, in line with the 1969-1970 recession.

That's well behind the 10.1% plunge in output when the pandemic struck in the spring of 2020, or the 3.8% drop during the financial crisis, her report showed. However, she noted that the S&P 500 plunged 32% during the 1969-70 recession, which may give stock-market investors cause for concern.

Moreover, she emphasized that the painful impact of inflation and rate hikes could be exacerbated by the Russia-Ukraine war, the slowing Chinese economy, and mounting tensions over Taiwan.

"While economic momentum has protected the US economy this year, what's around the bend in 2023 is the bigger worry," she said. "The US economy appears to be teetering toward recession."

Although the latest US jobs report was better than expected, Bovino warned the looming downturn could drive unemployment up from 3.7% in October to 5.6% in the fourth quarter of 2023. It might still be hovering around 4.7% by the fourth quarter of 2025, she added.

Bovino also advised against assuming the Fed, which has approved four straight jumbo hikes of 75 basis points in recent months, will begin slowing its pace of increases in December.

"We believe another 75-basis-point rate hike for the holidays is still on the table," she said. "While the healthy jobs report supports a strong holiday period, it's one that is a little less merry for the Fed as the window for a soft landing closes."

Read more: Money managers say these 10 stocks are screaming buys despite rampant inflation and lingering recession fears, according to Morningstar

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