Fed steering U.S. economy toward ‘greater risk of recession’: Economist

RSM Chief Economist Joe Brusuelas joins Yahoo Finance Live to discuss what to expect from the Fed's FOMC meeting, GDP growth, inflation, and the outlook for recession risks.

Video Transcript

BRIAN SOZZI: Federal Reserve is poised to begin its rate hiking cycle later on today, and it will come against a backdrop of weakening macroeconomic data, rising geopolitical risks, and stubbornly high inflation, but does that mean recession risk is about to jump? RSM chief economist Joe Brusuelas is here. Joe, it's good to get some time with you. And full disclosure-- I was reading your note to us this morning here. I opened it, I clicked it out, I opened it again. You mentioned that recession risk could be on the rise after today's meeting. I'm not used to hearing that type of stuff from you.

JOE BRUSUELAS: No, I mean, but look, you have to call it as it is, right? We're about to embark on what's going to be a pretty serious hike rate cycle. While I only expect four rate hikes this year, the market's pricing in seven. The Fed will probably tell us they're planning on six this year.

And given the set of current conditions where geopolitical conflict is clearly at the forefront of all policy decisions, it's hard to think that the Fed's going to thread the needle to such a point that they bring the economy in for a soft landing, given the Putin price shock on top of the Fed being behind the curve and the type of inflation that we're looking at.

Look, Brian, you know that we put out a shock model estimate of the US economy, should oil prices rise, just before the invasion of Ukraine by Russia. Told us that we thought, well, we shaved about 1% to 1 and 1/2% off GDP, OK. That gets us from 4 to 2 and 1/2 with downside risk.

But the problem is, you were going to see a pretty significant increase in inflation to the point where given that the price shock that the economy is now absorbing, it's hard for me to see that we don't have a month or two where the inflation rate goes above 10%. At that point, the Fed really doesn't have much of a choice, but to begin to tighten, and then that will create a greater risk of recession.

JARED BLIKRE: Joe, I have a pointed question to you about the 10-year. But first, I have to address the elephant in the room, and that is your dapper look. It looks like you just stepped off of a Savile Row there. I don't know if it's a Huntsman or a JP Hackett, but looking nice.

Now I want to address everybody's attention or direct everybody's attention to the YFi Interactive, where I am looking at the 10-year T-note yield back to the 80s. And we can see this very firm downtrend line here, not drawing it perfectly, but have yet to break to the upside. But Joe, what is it-- what does the world look like? What does the economy look like? What do markets look like, if and when that eventually happens? Because it looks like we're on the precipice.

JOE BRUSUELAS: Well, clearly, the long-term yields are going to begin to rise. Now what we're going to get today out of the Fed is they're going to be dealing with what I call the conventional portion of their policy toolkit, which is the federal funds rate. The policy rate is going to go up by 25 basis points. And we're likely to see that rise well above 1% this year. Now, I'm not expecting a forward-looking strategy on how they're going to draw down the balance sheet. I'm expecting Powell to talk about that, but perhaps that's going to be in the next meeting or even out to June.

Now that's at the point when they begin to draw down the balance sheet, and they begin to sell mortgage-backed securities back in the market. If, indeed, they do, the long end of the curve will begin to rise significantly. So you'll see policy normalization advance even as we navigate and the Fed navigates these very potent financial, economic, and geopolitical crosscurrents, which I got to tell you that this is one of the more tougher situations I've seen in my career arc.

BRIAN SOZZI: Joe, you know, we're so fixated on a recession, but remind folks out there, recession technically are two quarters back to back of negative growth. It is still hard to see that happening this year. And to that end, do you see perhaps one quarter of negative GDP later this year?

JOE BRUSUELAS: So I think if we have a negative quarter of growth, it's likely to be the first quarter of the year because that will capture the price shock that's cascading through the economy, plus the sort of-- the hangover after the very strong finish to last year. Look, I don't think we're going to have a recession. Right now, if you take a look at the data, it says 15% probability. If I use the yield curve, I can kick that up to about 1 in 3. So I really don't see it this year.

We would have to have a far greater cataclysm in Europe than we're already having, meaning the Russians get their oil exports cut off by the Europeans, their natural gas exports cut off by the Germans, and then you'll see a resumption in the direction of the price of oil. But we're not there yet. And I think it is premature to be just doing a 01 calculation that we're growing at 4% or we're in recession. That's not the case.

When you see the Fed's summary of economic projections today, the last one we had in December was forecasting a 4% rate of growth. That was spot on with my forecast. That's clearly not the case. I'm at 2.5 with downside risk. My good friends over at Goldman Sachs will tell me 1.75. OK, that's a nice, healthy space to be in. Remember, the long-term growth rate of the United States is 1.8%.

If we're going to move back to trend, not what we wanted, not what we expected coming out of what we might call the end of the final phase of the pandemic. But it's better than nothing. Unemployment rate is going to fall to 3 and 1/2%. But again, the real problem is inflation. It's lost purchasing power on the part of households. And we have yet to see how this goes.

Now this is important here. We put out a piece this week called "Life During Wartime, Inflation Price Controls and Economic Conflict." When you see these broad global wars occur, inflation goes up and noticeably. Typically, economies opt for price controls. But we don't think that's the proper policy path, but you're going to start hearing it. You're already hearing it about rent control. You'll begin hearing all sorts of things from backbenchers about we ought not to export this, and we ought not to export that.

That's not the way to go here. The way to go is to let the Fed begin to slowly advance its policy normalization campaign in a way that doesn't unnerve investors. The economy is going to slow. It doesn't mean the economy is going to go to zero. And I think it's really important when we have these conversations that we don't get trapped in the corner solutions, nor do we get trapped in excess commentary. We just are in a very difficult situation right now. The Fed is going to have a hard time engineering a soft landing. We don't know what that landing is going to look like. And hey, it's going to give us a lot to talk about over the next couple of years.

BRIAN SOZZI: John, I want to make sure I heard you correct. So there is a probability that growth in the first quarter is negative. What would that look like, and is that priced into the market?

JOE BRUSUELAS: No, I don't think it's quite priced in the market yet. But, you know, like, when you saw the retail sales today, right, the control group, which is the one that the Bureau of Economic Analysis uses to estimate GDP out of that data, it declined 1.2% for the month of February. Now on a three-month average annualized pace, it's increasing at around a 1% pace. Now that's OK, right? That's sort of in line with where I was prior to the invasion, which is I thought GDP, more or less, would be in there, around 1% to 1.2%.

So we're moving in that direction. But what I'm concerned with is the invasion, which happened on February 24, resulted in foot traffic at malls really hollowing out. Consumer confidence, as you saw last week in the University of Michigan, really cratered.

And we might have an oversized pullback, especially as households, especially people who have to commute 30, 40, 50 miles one way to work, really found themselves in a difficult situation, where gasoline prices, which, by the way, are up 21.5% since February 23-- think about that. February 23 to March 15, not even one month, gasoline prices are up over 21%. You're going to get something of a shock there, right? And so that's why we've seen the volatility in asset markets and especially in the equity market.

BRIAN SOZZI: I'm trying not to think about it, Joe. Those trips to the gas station are getting ever painful, but always appreciate your insight. RSM chief economist Joe Brusuelas, we'll talk to you soon.