Only 'miracle' stands in way of US recession

As Fed raises rates, economy can't dodge decline, influential analyst says

The United States will need a "miracle" to steer clear of a recession, according to a leading economist.

"We'll definitely have a recession as the lagged impacts of this major monetary tightening start to kick in," Stephen Roach, a former chairman of Morgan Stanley Asia, said on Monday. "They haven't kicked in at all right now."

Roach, also a Yale University senior fellow and a former Federal Reserve economist, suggested on CNBC's Fast Money program that Federal Reserve Chairman Jerome Powell has no choice but to take a Paul Volcker-style approach to tightening rates.

Volcker, who was Fed chairman from 1979 to 1987, raised interest rates to a peak of 20 percent in 1981 to battle rampant inflation, although rates likely could never come near that level in today's political environment.

The current Fed target interest rate is a range of 2.25-2.5 percent.

"Go back to the type of pain Paul Volcker had to impose on the US economy to wring out inflation. He had to take the unemployment rate above 10 percent," said Roach.

The economist said he was concerned about the US-China relationship, which he writes about in his new book Accidental Conflict: America, China and the Clash of False Narratives, due for release in November.

"In the last five years, we've gone from a trade war to a tech war to now a cold war," Roach told CNBC. "When you're in this trajectory of escalating conflict as we have been, it doesn't take much of a spark to turn it into something far more severe."

Roach also expects the global economy will slide into a recession.

The US unemployment rate stands at 3.5 percent, the lowest level since 1969. The next report will be released on Friday; analysts expect the rate to remain steady.

Significant tightening

"The fact that it (an increase in unemployment) hasn't happened, and the Fed has done a significant monetary tightening to date shows you how much work they have to do," he noted.

"The unemployment rate has got to go probably above 5 percent. Hopefully, not a whole lot higher than that. But it could go to 6 percent.

"We're going to have to have a cumulative drop in the economy (GDP) somewhere of around 1.5 percent to 2 percent. And, the unemployment rate is going to have to go up by 1 to 2 percentage points at a minimum. That would be a garden variety recession."

The US has had two straight quarters of negative GDP growth in 2022, which has traditionally been the standard for a recession, although the White House has contested that measure.

The economy contracted 0.9 percent in the second quarter after a 1.6 percent decline in the first quarter.

Inflation, which has driven the Fed's tightening spree, has hovered around 8-9 percent this year.

On Tuesday, global stocks tumbled for a third consecutive session over concerns about likely US and European interest rate increases.

"Equity markets continued to be impacted by expectations central banks will keep their foot on the accelerator in terms of rate hikes," analysts at ANZ Research said in a note to clients.

Two-year US Treasuries reached a high not seen since 2007 after data showed job openings increased in July. This suggested that demand for labor was not slowing, bolstering the case for the Federal Reserve to stick to its hawkish tightening path.

To discourage speculation that the Fed might cut rates next year to support economic growth, New York Federal Reserve Bank President John Williams said on Tuesday that the central bank likely needs to lift its policy rate above 3.5 percent and was unlikely to cut rates at all next year.

A poll by the National Association of Business Economics found that 72 percent of economists are expecting a recession by mid-2023.The poll also found that 19 percent of economists believe the US is already in a recession.

About 73 percent of forecasters said they were not confident or not that confident that the Fed can pull inflation back in the next two years without a recession unfolding.

Agencies contributed to this story.