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Central banks are tightening in a 'synchronized, but uncoordinated' manner: Economist

EY-Parthenon Chief Economist Greg Daco breaks down the recession indicators across American and European markets, the Fed's economic and employment challenges amid inflation, and supply-demand rebalances.

Video Transcript

SEANA SMITH: Investors debating whether the economy still has room for a soft landing or if we're heading into a recession. Here to break down where things are in his assessment of the economy, we want to bring in Greg Daco, EY Parthenon chief economist. Greg, it's great to see you. So certainly markets have reacted negatively to this latest rate hike. We're looking at losses. Once again today, the Dow staying under 30,000, pretty close to 29,000. S&P making a new close-- new closing low for the year. What do you think? Is there still a chance of a soft landing?

GREG DACO: I think the chances of a soft landing are really small right now. We are looking at a US economy that is slowing under the weight of persistently elevated inflation where we're seeing increased business uncertainty as to investment and hiring decisions. And as I think about the outlook for 2023, I think the odds are fairly high that we will end up in a recession. This comes in the context of an environment where the global economy is also slowing at quite a rapid pace and where policy and political developments are making the outlook for 2023 even more uncertain.

SEANA SMITH: Greg, how deep of a risk of a recession are you expecting?

GREG DACO: Well, that's the big question on everyone's mind, is no longer whether we see a slowdown in economic activity or not, but whether we see a deep one and a prolonged one. If we look at US fundamentals in terms of household finances, they still look relatively healthy. We have elevated levels of excess savings. We have elevated levels of wealth. We have low levels of leverage overall. But these are all increasing.

So from a starting point, the position of households in the US is stronger than in prior recessions. The corporate sector is a little bit less healthy, but still not unhealthy as a starting point for this potential recession. So those are positive signs, but I think we have to keep in mind that we're in an unusual environment where all central banks are tightening in a synchronized manner, but in an uncoordinated manner. And this combined tightening of monetary policy around the world will have consequences that I'm not sure everyone is capturing at this point.

RACHELLE AKUFFO: And so when you look at, obviously, what the Fed is looking at is backwards looking when you look at some of the CPI data-- and there was concern that perhaps you should sort of wait and sort of see how these things are impacting the real economy before continuing to be so aggressive. What's your take on that?

GREG DACO: Well, I think all central banks and all policymakers right now are convinced that they need to regain control over inflation. They were all a bit late to the game in terms of tightening monetary policy in the face of what has become persistently elevated inflation. And they want to regain control over the inflation and the inflation narrative. And in doing so, they will want to tighten monetary policy quite aggressively, continue doing so, even if that entails some pain in the form of higher unemployment rate, and as Powell said, it below potential trend growth.

That means, essentially, that the Fed and other central banks are looking for a significant cooling of demand, a significant tightening of financial conditions. And they won't back down at the first signs of an economic slowdown. If anything, that slowdown is what they want to see to hope for lower inflation. So I think the bar next year for rate cuts is actually quite high on the Fed front. And for other central banks, including in Europe, the question is a little bit different, given that the economic backdrop is weaker and given that we are likely to face a fairly difficult winter on the energy front in Europe.

SEANA SMITH: Greg, let's talk about some of the consequences of the Fed tightening unemployment, right? The Fed has a 4.4% unemployment projection for 2023. How high do you see unemployment potentially going?

GREG DACO: I think it's very possible that we could see a five hand on the unemployment rate by the middle of next year. If we look at how the environment in terms of the labor market is evolving, we know that businesses and business executives have a different view of talent post-pandemic. They view talent as much more valuable because it's less available and because it costs more. But we are starting to see more strategic decisions being made in terms of reducing the pace of hiring, in terms of strategic layoffs.

I think that as we fast forward six months into 2023, we're going to be in an environment where job growth will have slowed quite significantly, where we might have seen a couple of negative job prints, and where the unemployment rate will be trending higher. So I think 4.4% by the end of next year, which is the Fed's forecast for the unemployment rate, may be even on the conservative side. I wouldn't be surprised to see the unemployment rate rising towards 5% by the middle of next year.

RACHELLE AKUFFO: And Greg, Fed Chair Powell did indicate that he is keeping an eye on international developments, of course, what other central banks are doing. Obviously, the energy crisis in Europe and so forth. And then, of course, you have this issue with the strong dollar. What are your expectations there? When do you expect to see perhaps that cool? And what sort of domino effects are you still expecting to see in the economy if this persists?

GREG DACO: I think you're absolutely right to point out that the global landscape is making the current headache of policy making even more damaging because we are in an environment where the global landscape in terms of economic activity in Europe, in Asia, is cooling more significantly than in the US. We're seeing political developments in Europe with the Italian elections just now. We're seeing developments in the UK with the mini budget and the risk of that putting higher pressure on inflation and leading potentially to a currency crisis.

All of these troubles that we're seeing around the world will wash up on US shores and affect economic activity in the US, also affect morale and confidence, which is already depressed. So we have to be conscious of the fact that what happens in the rest of the world does not stay outside of the US. It will have an effect on economic activity.

I think to that extent, Powell is right to highlight that they will be monitoring international developments. I'm a little bit less optimistic in terms of the view of the global economy going into 2023. I think we risk a recession that is more pronounced that's currently priced in. And that is a downside risk for the US economy going into next year.

SEANA SMITH: Greg, let's also talk about consumers. Certainly, consumers have been pretty resilient so far in this economic slowdown that we have been seeing. Now we're seeing a slowing in housing, mortgage rates above 6%. What's your assessment of just how consumers are feeling right now?

GREG DACO: Well, consumers are not feeling good. I mean, we see it in the confidence readings that are near all-time lows in terms of sentiment readings, for instance. We have an environment where inflation is not just elevated, but it's broad-based. It's affecting most every sector that consumers are in. And it's been persistent. It's been lasting for quite a bit of time. So households across the US are facing this significant pinch.

And they're noticing that while they're spending more, they're buying less. And that is really a key concern, as we move into next year. Interest rate sensitive sectors like the housing sector are also feeling the pain, with mortgage rates approaching 7%. That is a big, big hit for potential home buyers. And that will mean even reduced activity on top of slower consumer spending.

RACHELLE AKUFFO: And sticking with the consumer, in terms of where we are with supply and demand, are we seeing any sort of leveling off at this point, any sort of parity coming in now?

GREG DACO: We are in some sectors. We are starting to see this delicate rebalancing act taking place. And as you correctly note, one of the big issues right now is that there are a number of sectors that are still imbalanced. As we look into next year, we're going to see more of that rebalancing taking place. But any rebalancing is rarely smooth. Usually, what happens is that you have an overshoot on one side of the ledger or on the other. In the current environment, we're seeing some easing supply pressures, but we're also seeing demand that is cooling.

So both sides of the ledgers are being worked on by the Fed and by economic conditions overall. And so this rebalancing effect will likely take more than just a couple more months. It's probably going to take a year or 18 months before it actually levels out. So I think we are going to be in an environment where we're going to have to learn to navigate this macroeconomic uncertainty. And for businesses, this really requires focusing on resilience, building resilience on the talent front, building resilience on the organizational front, on the supply front, to ensure that they are able to navigate this period of uncertainty.

RACHELLE AKUFFO: That certainly sounds like a holistic approach needed, indeed. A big thank you to Greg Daco there. Thank you for joining us this afternoon.