Negative economic growth in the first half of the year may be a harbinger of a much deeper downturn that could last until 2024.
Stephen Roach, who served as chairman of Morgan Stanley Asia, warns that the US needs a “miracle” to avoid recession.
“We’re definitely going to have a recession as the lagged effects of this big monetary tightening start to kick in,” Roach told CNBC’s “Fast Money” Monday. “Now they haven’t kicked it at all.
Roach, a senior fellow at Yale University and a former Federal Reserve economist, suggests that Fed Chairman Jerome Powell has no choice but to take Paul Volcker’s approach to tightening. In the early 1980s, Volcker aggressively raised interest rates to tame rampant inflation.
“Go back to the pain Paul Volcker had to inflict on the US economy to offset inflation. He had to take the unemployment rate above 10%,” Roach said. “The only way we won’t get there is if the Fed under Jerome Powell keeps its word, focuses on discipline and gets the real federal funds rate into the curb zone. And the containment zone is far from where we are right now.”
Despite the Fed’s steep rate hike trajectory, the unemployment rate is at 3.5%. It is at its lowest level since 1969. That could change on Friday when the Bureau of Labor Statistics releases its August report. Roach predicts that the pace needs to start picking up.
“The fact that that hasn’t happened and the Fed has done significant monetary tightening to date shows you how much work they have to do,” he noted. “The unemployment rate probably needs to get above 5%, hopefully not much higher. But it could go up to 6%.
The ultimate tipping point may be consumers. Roach speculates that they will soon capitulate due to persistent inflation. Once they do, he predicts that the drop in spending will reverberate through the broader economy and cause pain in the labor market.
“We will have to have a cumulative decline in the economy [GDP] somewhere around 1.5% to 2%. And the unemployment rate will have to go up at least 1 to 2 percentage points,” Roach said. “That would be a garden variety recession.”
“Cold War” with China
The prognosis abroad is not much better.
He expects the global economy to fall into recession as well. He doubts that China’s economic activity will moderate the impact, citing the country’s zero-Covid policy, severe supply chain backlogs and tensions with the West.
Roach is particularly worried about U.S.-China relations, which he writes about in his new book, “Accidental Conflict: America, China and the Clash of False Narratives,” due out in November.
“In the last five years, we’ve gone from a trade war to a technology war to the current Cold War,” Roach said. “When you’re on this trajectory of conflict escalation like we were, it doesn’t take much of a spark for it to turn into something much more serious.”