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Economist explains why a recession next year won’t feel like 2020 or 2009

Jefferies Senior Economist Thomas Simons joins Yahoo Finance Live to discuss when the impact from Fed rate hikes will hit the economy, positive indicators, and the outlook for a mild recession.

Video Transcript

BRAD SMITH: The Street is currently expecting a recession sometime in the first quarter of 2023. But our next guest says it will take a bit more time. Joining us now, we've got Jefferies senior economist, Thomas Simons. Thomas, great to have you here with us today. Help us really run through what your expectations are and why and when-- why in terms of the catalysts and then when in terms of timing you're expecting a recession to hit.

THOMAS SIMONS: Sure, so I think, yeah, the main difference between our call and many of our competitors is just the sense that the economy is really approaching this period of time from a position of much greater strength than it typically does as it rolls into a recession. So you pointed out just the chart before you had a couple of quarters of negative GDP growth, but Q3 is really shaping up to be quite a bit stronger.

In Q4, you know, I don't have any expectations that we're going to end up with a negative number again. It's really into the second half of next year that we're going to start to see the cumulative effects of all the hikes start to really hit, and plus the strength of the dollar as well. I don't think that we've really seen much evidence that that's actually taking a big bite out of economic activity just yet because the economy is just generally less interest rate sensitive than it normally is at this point in the business cycle.

Lots of consumers and businesses already have a lot of locked in cheap borrowing that is-- doesn't need to be refinanced any time soon. You look at things like mortgage rates and these sorts of things that are spiking. But, you know, consumers don't have a lot of adjustable rate loans.

So the same sort of dynamic is at play with businesses, with balance sheets are very, very strong. We haven't seen much margin compression just yet either. These sorts of things, we expect, are going to start to really take hold into the second half of 2023, especially as the Fed continues to raise interest rates here.

JULIE HYMAN: Thomas Mann, we have been on the drumbeat for this recession for what feels like so long now. And now it sounds like according to you, we're going to be on it for quite a while longer before we actually get there. You, in your latest note, have this sort of scenario that you're painting of entering it later. And then, I believe in the first quarter of 2024, seeing the worst of it with the drop in-- of 2.3% in growth here-- or in GDP, I should say.

What is that going to feel like? How does that comport with what we are hearing generally, painting a picture of a relatively mild recession? I mean, 2.3%, is that a relatively mild recession?

THOMAS SIMONS: Not when it all happens in one corner. It's not going to feel particularly great. One thing to keep in mind is that it's not going to feel like 2020, and it's not going to feel like 2009 either. Even though 2.4% or thereabouts for a quarterly decline is something that we are not used to and seems like a lot in the context of some pretty positive growth rates we've seen recently, it's not totally out of the question relative to how the economy used to behave before the financial crisis.

So, I mean, I think it's interesting that just in the past segment that we had before, we're talking about all these comments from CEOs about how the inventory cycle isn't as bad as they thought, margins are still good, pricing power is still pretty well retained, these sorts of things are what's going to push us a little bit further and is what, again, is going to have to make the Fed raise rates even a little bit higher and is going to cause us to fall further and faster and slow down faster when we get into the second half of 2023 and into 2024, like you mentioned as well.

BRIAN SOZZI: So, Thomas, against this backdrop of a recession next year at some point of some magnitude, what happens to inflation?

THOMAS SIMONS: So inflation, we expect, is going to gradually slow through this year, the remainder of this year and into next year. We probably have peaked, I want to say, although I feel like we've been saying that inflation has peaked since March of this year, something like that. And yet, we continue to see this really sticky pressure in a lot of the core measures. Specifically, housing seems to be what's pushing us recently.

I do think that as we get into the second half or into the first half of next year-- excuse me-- we will see a gradual decline and then more of a acceleration of that decline as we get into the second half of next year as unemployment rises. It's really, that's the key, is that the Fed needs to raise rates to lower demand, which is going to lower employment, raise the unemployment rate, and get us to lower inflation eventually into next year.

The question is, how much does unemployment have to really rise, right? That's certainly an open point of debate at the Fed right now. We think that the unemployment rate probably has to get above 5% before we're going to get meaningful significant deceleration towards target for inflation because with inflation so high as it is now, it can decelerate a lot and still be uncomfortably above target for the Fed.

JULIE HYMAN: 5%, ouch. All right, Jefferies senior economist Thomas Simons, thank you so much. Really appreciate your perspective here.