Bank of America sees mild recession in Q4; inflation remains the biggest threat to consumption

NEW YORK (July 19)  Recession fears continue to rise as the second largest bank in the U.S. expects to see a mild contraction by the end of the year.

In a report published last week, Michael Gapen, U.S. economist at Bank of America Global Research, said he sees the fourth-quarter real GDP falling 1.4% for the year. Previously BofA was expecting the U.S. economy to avoid a recession this year.

"Our previous baseline outlook for the U.S. economy featured a growth recession, with output growth falling below our estimate of potential growth while avoiding an outright contraction. However, a number of forces have coincided to slow economic momentum more rapidly in recent months than we previously expected, and we have taken the signal from this data on board," the report said.

Specifically, the bank noted that consumer spending, according to credit card and debit card activity, is losing momentum. According to Gapen's research, the biggest risk to the U.S. economy remains the persistent rise in inflation.

Last week, the Consumer Price Index rose 9.1% for the year in June, hitting a fresh 40-year high.

"With much of the recent rise in inflation coming from food and energy prices, commodities that face relatively inelastic demand in the short run, households may have less available for discretionary purchases," the report said.

Bank of America also noted that new homeowners face higher mortgage costs and rising home prices, which is weighing on the housing market, a critical component of U.S. GDP.

Gapen said that the housing sector could continue to see a further loss in momentum as the Federal Reserve raises interest rates. Bank of America expects the U.S. central bank to raise interest rates by another 75 basis points later this month and by 50 basis points in September.

"FOMC participants have expressed their commitment to restore price stability first and foremost," Gapen said in the report. "Our revised outlook suggests the Fed will indeed have to accept more pain than it wants, but should our outlook prove accurate, we think it's a price most FOMC participants would be willing to pay."

Bank of America's recession call comes as many economists have said there is hope that the U.S. economy can avoid a recession if the labor market remains strong and consumption remains solid.

At the same time, many economists have also said that the U.S. is already in a recession. According to data from the Atlanta Federal Reserve, U.S. Q2 GDP has declined 1.5%, which follows the 1.6% contraction seen in the first quarter. The traditional definition of a recession is two quarters of consecutive declines.

However, Bank of America noted that the decline in the first quarter was due to many trade issues.

"We will leave the debate over whether the U.S. is currently in recession to others…," Gapen said. "Although a rebalancing of trade and inventories was responsible for much of the weakness earlier this year, the main driver of weakness in our forecast going forward is private consumption, which we see as in the early stages of a more pronounced rebalancing. Relative to our prior forecast, the main change, in our view, comes from services, where we now look for less momentum."

Although Bank of America sees a recession at the end of the year, the bank also sees the U.S. economy growing 1% next year.

Gapen noted that as the U.S. central bank front-loads its monetary policy now, demand destruction caused by the recession is expected to bring inflation under control and back down to the 2% target by 2024.

" With inflation pressures clearly moderating in our outlook by the middle of 2023, we think the Fed would then find itself in a position where it could move from a restrictive monetary policy stance to neutral," the report said. "Hence, our outlook includes four 25bp rate cuts beginning in 3Q 23, bringing the target range for the federal funds rate to 2.25-2.5% by mid-2024."

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