U.S. needs miracle to avoid recession, economist Stephen Roach warns

Negative economic growth in the year’s first half may be a foreshock to a much deeper downturn that could last into 2024.

Stephen Roach, who served as chair of Morgan Stanley Asia, warns the U.S. needs a “miracle” to avoid a recession.

“We’ll definitely have a recession as the lagged impacts of this major monetary tightening start to kick in,” Roach told CNBC’s “Fast Money” on Monday. “They haven’t kicked in at all right now.”

Roach, a Yale University senior fellow and former Federal Reserve economist, suggests Fed Chair Jerome Powell has no choice but to take a Paul Volcker approach to tightening. In the early 1980’s, Volcker aggressively hiked interest rates to tame runaway inflation.

“Go back to the type of pain Paul Volcker had to impose on the U.S. economy to ring out inflation. He had to take the unemployment rate above 10%,” said Roach. “The only way we’re not going to get there is if the Fed under Jerome Powell sticks to his word, stays focused on discipline, and gets that real Federal funds rate into the restrictive zone. And, the restrictive zone is a long ways away from where we are right now.”

Despite the Fed’s sharp interest rate hike trajectory, the unemployment rate is at 3.5%. It matches the lowest level since 1969. That could change on Friday when the Bureau of Labor Statistics releases its August report. Roach predicts the rate is bound to start climbing.

“The fact that it 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%, hopefully not a whole lot higher than that. But it could go to 6%.”

The ultimate tipping point may be consumers. Roach speculates they will soon capitulate due to persistent inflation. Once they do, he predicts the pullback in spending will reverberate through the broader economy and create pain in the labor market.

“We’re going to have to have a cumulative drop in the economy [GDP] somewhere of around 1.5% to 2%. And, the unemployment rate is going to have to go up by 1 to 2 percentage points in a minimum,” said Roach. “That would be a garden variety recession.”

The prognosis abroad isn’t much better.

He expects the global economy will also sink into a recession. He doubts China’s economic activity will cushion the impact, citing the country’s zero-Covid policy, serious supply chain backlogs and tensions with the West.

Roach is particularly worried about the U.S. and China relationship, 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 tech war to now a cold war,” Roach said. “When you’re in this trajectory of esclating conflict as we have been, it doesn’t take much of spark to turn it into something far more severe.”

Disclaimer