SFC Markets and Finance | Gary Hufbauer: U.S. economy may face a shallow recession in 2025

南方财经全媒体记者 见习记者梁旭琦 广州报道

As the global economy navigates a period of significant uncertainty, with looming signs of a slowdown, understanding the underlying economic dynamics has never been more critical. Particularly in the United States, concerns are mounting about the potential onset of a recession in 2025. Amid these evolving conditions, the Federal Reserve's strategies on interest rates are under intense scrutiny, especially as the U.S. heads towards a pivotal presidential election which could further influence monetary policy.

Adding to the economic context is the upcoming release of the personal consumption expenditures price index by the Commerce Department, expected at 8:30 a.m. ET this Friday. The July reading, which observed slight monthly increases and annual gains of 2.5% and 2.7% in headline and core prices respectively, sets a crucial backdrop for the Fed’s forthcoming rate decision in September. This data is anticipated to be a key determinant in the Fed's policy trajectory, even as the focus of policymakers seems to be shifting.

Amidst these critical developments, we sit down with Gary Hufbauer, a nonresident senior fellow at the Peterson Institute for International Economics. In this interview with SFC Markets and Finance, Gary discusses the anticipated moves of the Federal Reserve, analyzing how these could impact the U.S. and global financial landscapes. This conversation also explores the intricate balance of economic indicators and policy decisions in a time of potential transition and challenge. Join us as we delve deep into these issues.

SFC Markets and Finance: Let’s dive right into the heart of our discussion. Given the current economic climate, what kind of rate cut are you anticipating from the Federal Reserve and what are the critical factors that you think will drive their decision?

Gary Hufbauer: We'll see a 25 basis point reduction at the September 18 meeting. The critical factors are, first, that the labor market is slowing down a bit. But the second critical factor is that, as you know, we're quite close to the election, and the Federal Reserve does not want to appear to be supporting the incumbent party, that is Vice President Harris, in the election. So, it wants to be cautious on this rate move in September and not make too much noise.

SFC Markets and Finance: Given these factors, how long do you expect these rate cuts to continue?

Gary Hufbauer: I think it's going to be for a year. I think we're going to get a second cut in November. The November meeting is right after the election, so whatever they do in November won't affect the election or be seen to affect the election. But the reason I think it's a year is that my view is that the labor market is going down, and we're going to see more rising unemployment and slowing economy in the year 2025, and consequently, if that view is correct, The Federal Reserve will compensate by cut, cut, cut, cut.

SFC Markets and Finance: Chairman Powell has recently placed greater emphasis on the job market over immediate inflation concerns. How do you think this shift will affect the Fed's policy actions in the upcoming months?

Gary Hufbauer: As long as inflation stays at about the current rate, which is about 2.5%, then I think the total focus will be on jobs and the unemployment rate. The duration of unemployment, whether it's increasing because more people are trying to get work, or it's increasing because there are more layoffs, all those kinds of factors will affect the Fed's thinking. But I believe unemployment or employment figures will be the dominant talking point for the next 12 months.

SFC Markets and Finance: Moving on to recent communications from the Fed, beyond potential rate cuts, what significant messages did Chairman Powell's speech at Jackson Hole convey to markets and investors?

Gary Hufbauer: Well, Chairman Powell is very aware that there can be surprises, pleasant surprises and unpleasant surprises. And so he deals with that by this framework, where he says our decisions are data-dependent. So what that means is that if the numbers change, in particular, if there’s a bad surprise, and inflation goes up, let’s say above 3% like to 3.2% or something like that, then he’ll shift. Another thing he says, but central bankers always say this, is that the budget deficit should be reduced. Now he doesn’t say whether it should be reduced by increasing taxes or lowering spending. He leaves that to Congress. The US budget deficit is now about 7% of gross domestic product. I mean, that’s a big number for the U.S.

SFC Markets and Finance: With the Fed's last rate decision coming just before the U.S. election, how do you expect the financial markets to react?

Gary Hufbauer: If I'm right, and it's a 25 basis point reduction, I don't think it'll have any effect on the financial markets, because that's very well built in. Now, the surprise would be if it's a 50 basis point cut, bringing the target rate to 4.75% to 5.0%. That would, well, I would say two things. One, that the unemployment outlook is worse than had been expected, that would be one kind of negative thought, but also would mean that, that's usually good for the stock market. When the interest rate goes down, there'll be two opposing forces, but I think it would probably mean an upward move in the stock market if it was a 50 basis point cut, as I say, I'm not expecting that.

SFC Markets and Finance: Turning our attention to upcoming economic indicators, with a renewed emphasis on employment over inflation, how does the Fed integrate PCE data into their interest rate decisions? Has there been a significant shift in this approach?

Gary Hufbauer: They've been pretty clear that they're depending on the personal consumption expenditure guide, the PCE guide. The way they vary their approach is they can talk about a one-year move in the PCE, or six months' move in the PCE, or three months' move in the PCE, the market can talk about a one-month moving the PCE. So by emphasizing a different period, they could put a little different spin on their outlook. So for example, if the PCE wasn't very good these last the most recent three months, but it looks pretty good for a six month or one-year period, and the Fed is still focusing on jobs, it might emphasize the six-month or one-year period rather than the most recent three-month period. That's kind of the flavor. But they really can't get away from the PCE without a big change if they actually, let's say, shifted from the PCE to the consumer price index, the CPI, that would be quite a big policy shift. I don't think they'll do that, but it's possible they might, under some circumstances.

SFC Markets and Finance: On a more global scale, as the U.S. potentially lowers its interest rates, what effect might this have on debt servicing and foreign investment flows into emerging markets?

Gary Hufbauer: For some time now, by which I mean a couple of years, capital flows to emerging markets have been down, and if you look at the exchange rates, for the most part, for the last couple of years, the exchange rates of emerging market currencies have dropped relative to the dollar. So their stock markets are weak, and exchange rates are down. If the US goes, as I am thinking, on this cycle of a downward movement on the Federal Reserve policy rate, and maybe gets down as low as 3.75% to 4%, that will encourage capital flows to emerging markets, so that would reverse somewhat what's been happening for the last couple of years, and their exchange rates would strengthen.

Now, in the case of China, there's the special circumstance of the geopolitical tension between the US and China. So the effect would not be maybe so direct of US capital moving to China, but it would be other countries' capital, notably Europe and Japan, big sources of capital. And other places, Australia and Canada for example, are not big sources, but are sources. I think the flows would come that way into China. And I think the Chinese RMB has been a little weak against the dollar, it would tend to strengthen it somewhat.

SFC Markets and Finance: Related to those dynamics, can you discuss how rate cuts might affect currency exchange rates?

Gary Hufbauer: When a country cuts its interest rate relative to other countries, its currency weakens; if it raises its interest rates, its currency strengthens. So right now, for example, you're seeing the British pound the strongest it has been in about two years. And the reason for that is not that the Bank of England is raising rates, but that other countries, the European Union and the US, are lowering rates. So as the US lowers its rate, which I'm expecting, I think the dollar will weaken somewhat against other currencies, unless they, at the same time, do as much lowering as the US. But the US will probably do more lowering than other countries. As the US lowers relative to other countries, I expect the dollar to get a bit weaker in the next year. Like, when I say a bit, I mean, on a trade-weighted basis, maybe 5% weaker. That's a big number for a foreign exchange trader.

SFC Markets and Finance: With all these factors in play, what is your forecast for the U.S. economy for the remainder of this year, and where do you see interest rates heading by the end of 2024?

Gary Hufbauer: My forecast, which is a little more negative than most commentators, is that the US economy will flatten out and it will grow at under 2%. The economy is coming down. And I'm really thinking that next year, in 2025, we will get what I would call a shallow recession. When I say shallow, I mean the gross domestic product drops, but drops by less than 1%; however, it'll still be called a recession in the financial markets. If that's right, by the end of this year, I expect the Federal Reserve policy rate to be in the range of 4.75% to 5%. In other words, about 50 basis points lower. And if I'm right about the jobs, and considering that the December season, the Christmas season, is usually strong on spending and on jobs, and if it's not so strong, maybe we get down to 4.5% to 4.75%, with a cut in December. That would be kind of a Christmas cut by the Federal Reserve, and that's possible.

SFC Markets and Finance: To wrap up our discussion, you've suggested the likelihood of a shallow recession. Why do you think this scenario is more plausible than achieving a soft landing, as some analysts might argue?

Gary Hufbauer: The reason I think it should be a recession, or that we're heading for a recession, is that if you look at credit card indebtedness by households, those numbers are going up. In other words, the higher delinquency rate of paying off credit card debt. That's one reason. The second reason is the commercial real estate, like all these office buildings in Chicago, Los Angeles, New York, wherever. People are not going back to the office so much. They want to work from home a couple of days a week, and there's a lot of vacancy in the office market. And that means these buildings are not so valuable, and then they can't pay their debt, and that's another weakness in the economy. The general situation, which people don't talk about so much anymore, is the money supply, the M2 measure of money, which includes cash plus checking accounts, has been actually shrinking. People don't talk about that too much now, but historically, that's been a sign of weakness in the economy. So those are the measures that persuade me that perhaps, we're coming down.

So now, why do I think it'll be shallow? Well, the biggest reason is that the Federal Reserve has plenty of room to cut interest rates. So if I'm right that the jobs and unemployment numbers come in higher than expected, I expect the Federal Reserve will cut very sharply and quickly to counteract that. That's the biggest reason. The second reason is that if it looks like we're headed towards a recession, Congress will be more inclined to vote for some new spending package of some kind or another, than a lot of things they could spend money on. And while that won't happen quickly, that will somewhat slow down the rate of any decline in the economy. So those are my reasons, both for a recession, and a shallow recession.

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