Bank of America changes its recession call, predicting a soft landing ahead.

Bank of America changes its recession call, predicting a soft landing ahead.

U.S. Economy Set for Soft Landing as Recession Fears Subside

In a surprising turn of events, Bank of America Research’s latest U.S. Economic Viewpoint research note, written by Chief U.S. ANBLE Michael Gapen, paints a much more positive picture of the economy than previously forecasted. This marks a significant departure from Gapen’s consistent recession predictions over the past year.

When Gapen took over as BofA’s chief economist, he joined a growing chorus of Wall Street leaders predicting an impending recession. Factors such as rising interest rates and stubborn inflation led him to believe that a “mild recession” would occur by the end of 2022.

However, Gapen has since been forced to revise the timing of this recession forecast multiple times. Last September, he pushed the recession goalpost to the second half of 2023, citing underlying momentum in the economy despite aggressive interest rate hikes by the Federal Reserve. Then, in June, Gapen suggested the possibility of a “growth recession” in 2024, as there was evidence of resilience in the labor market. Just last month, he reaffirmed his prediction of a mild recession in 2024 but admitted that recent economic data had surprised on the upside and clients were feeling generally optimistic.

Now, Gapen’s pessimism has all but disappeared. In his research note to clients, he stated, “Recent incoming data has made us reassess our prior view that a mild recession in 2024 is the most likely outcome for the U.S. economy. We revise our outlook for the U.S. economy in favor of a soft landing, where growth falls below trend in 2024 but remains positive throughout our forecast horizon.”

So, what caused Gapen to change his mind? To fully understand his revised outlook, it is instructive to delve into the details and compare it with Goldman Sachs’ outlook, which has been leaning towards a soft landing for some time now.

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An Improved Outlook

Unlike many economists who anticipated fading economic growth this year due to rising interest rates, Gapen acknowledges that it hasn’t turned out that way. In fact, U.S. GDP growth for the first quarter was revised up to 2%, and it reached 2.4% in the second quarter, surpassing economists’ consensus forecast of 1.5%.

Additionally, Gapen and his peers were concerned that rising interest rates would cause a surge in the unemployment rate. However, despite a decline in job openings, the unemployment rate has stayed near record lows. ADP, a payroll firm, even reported that employers added 324,000 jobs last month, exceeding economists’ expectations of 189,000.

Goldman Sachs’ chief economist, Jan Hatzius, has been predicting a reduction in job openings without a sharp rise in unemployment since last September. He believes this will help slow inflation and enable a soft landing for the U.S. economy, keeping odds of a recession between 25% and 35%, which is near a Wall Street low. Now, Gapen’s forecasts are starting to align with his more optimistic counterpart.

For instance, Gapen’s view on inflation has also changed. After peaking at 9.1% last summer, year-over-year inflation dropped to just 3% in June. Gapen believes that wage and price pressures are moving in the right direction, making a wage-price spiral less likely. He points to various wage measures, such as the employment cost index (ECI), which shows a moderation in wage growth. In June, the ECI indicated a 4.5% year-over-year increase in compensation costs, compared to 5.1% during the same period the previous year.

Gapen also notes that sectors sensitive to interest rate changes, such as manufacturing and housing, have shown signs of stabilization in recent months.

A Soft Landing in Sight

After months of predicting that U.S. GDP growth would fall to 0% next year, the positive economic data led Gapen to revise his forecast. He now expects 2% GDP growth for 2023, 0.7% for 2024, and 1.8% for 2025. Similarly, the bank now projects the peak unemployment rate to be 4.3% in the first quarter of 2025, instead of their previous estimate of 4.7% in the fourth quarter of 2024.

Although Gapen expects inflation to decelerate and remain on a path towards 2.0%, he anticipates a more gradual decline than previously anticipated due to the ongoing strength of the labor market. He believes that the Federal Reserve’s preferred inflation gauge, the personal consumption expenditures (PCE) price index, will not reach its 2% target until the second half of 2025. Nevertheless, this would likely allow the Fed to gradually end its interest rate hiking campaign starting next year.

Gapen concludes his research note with a warning, despite his newfound optimism. He acknowledges that while he is replacing the expectation of a mild recession with a soft landing, there have been only three soft landings and eleven recessions since World War II. He recognizes that a lot still needs to go right for this favorable outcome to materialize.

The shift in sentiment among economists like Gapen, as well as Federal Reserve Chair Jerome Powell and ANBLEs polled by Bloomberg, underscores the growing optimism for the U.S. economy. While challenges and uncertainties remain, it appears that the U.S. may be headed for a softer landing than previously anticipated.