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Washington Watch: Economist sees ‘one in three’ chance of recession by end of this year

Rapid Federal Reserve monetary policy tightening along with potential disruption in China’s economy mean a one in three chance of a U.S. recession by the end of the year, a leading economist said Tuesday.

In a presentation on the U.S. economic outlook, Karen Dynan, a senior fellow at the Peterson Institute for International Economics, forecast a “soft landing” for the U.S. economy. After surging by 5.7% in 2021, U.S. GDP growth in the U.S. will slow to 3% annual rate this year and 2% in 2023, Dynan said.

But Dynan, who is also an economics professor at Harvard and the former chief economist at the U.S. Treasury Department, said the risks to this relatively benign forecast are to the downside.

To get inflation under control, Dynan forecast that the Fed will increase the Fed funds rate by three percentage points this year and bring its benchmark interest rate above 4% by the middle of next year.

Earlier Tuesday, the Labor Department reported that consumer inflation firmed to a 8.5% annual rate in March, the highest level in four-decades.

There is a risk that the Fed may have to tighten policy more sharply, especially if consumers start to expect higher inflation. Fed officials believe that how consumers view future inflation is an important driver of price behavior.

In this scenario, higher interest rates could cause asset prices to fall sharply and consumers to pull back, Dynan said. Coupled with other risks such as the possibility of much slower economic growth in China due to pandemic-related lockdowns, could weaken the U.S. economy substantially.

“So, all in all, I would put the odds of some combination of these factors pushing the economy into at least a mild recession by the end of the year at about one in three,” Dynan said.

U.S. stocks
DJIA,
+0.45%

SPX,
+0.57%

were higher on Tuesday and Treasuries
TMUBMUSD10Y,
2.712%

rallied after the “core” inflation reading in March was tamer than expected.

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