Morgan Stanley raises recession odds for the next year as inflation surges

The risk of a recession in the US is growing rapidly, according to Morgan Stanley economists, as stubbornly high inflation threatens to weigh on economic activity.

In a Monday analyst note, the bank strategists lifted their forecast of a recession in the next 12 months to 27%, a stark increase from March, when they projected just a 5% chance of a downturn this year. The increased probability of a downturn comes amid concerns that the Federal Reserve will be unable to achieve the elusive “soft landing,” the sweet spot between curbing consumer demand and cooling inflation without crushing economic growth, as it raises interest rates.

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“The probability of a hard rather than soft landing in the next 12 months has jumped to 27%,” Lisa Shalett, Morgan Stanley Wealth Management’s chief investment officer, wrote in the note.

inflation grocery shopping

A customer shops at a store in New York May 11, 2022. (Wang Ying/Xinhua via Getty Images/Getty Images)

Economic growth in the US is already slowing. The Bureau of Labor Statistics reported earlier this month that gross domestic product unexpectedly shrank in the first quarter of the year, marking the worst performance since the spring of 2020, when the economy was still deep in the throes of the COVID-induced recession.

The analysis comes amid growing fears on Wall Street that the Fed may drag the economy into a recession as it seeks to tame inflation, which remained elevated at 8.3% in April. Bank of America, as well as Fannie Mae and Deutsche Bank, are among the Wall Street firms forecasting a downturn in the next two years, along with former Fed Chairman Ben Bernanke.

Morgan Stanley Wall Street

People enter the Morgan Stanley headquarters building in New York April 11, 2018. (Christopher Lee/Bloomberg via Getty Images/Getty Images)

“It now appears that inflation is broadening out and has the potential to stay higher for longer,” Shalett said in the note. “This is a scenario that places upward pressure on longer-run inflation expectations and keeps the Fed in a policy acceleration mode.”

The Fed is now under mounting pressure to cool demand and prices but faces the tricky task of doing so without crushing economic growth. Policymakers raised the benchmark interest rate by 50 basis points earlier this month for the first time in two decades and have signaled that more, similarly-sized rate hikes are on the table at coming meetings as they rush to catch up with inflation.

Inflation food

Workers unload shipments of food at Union Market in Washington, DC, Feb. 9, 2022. (Stefani Reynolds/AFP via Getty Images) / Getty Images)

Fed Chairman Jerome Powell has acknowledged there could be some “pain associated” with reducing inflation and curbing demand but pushed back against the notion of an impending recession, identifying the labor market and strong consumer spending as bright spots in the economy. Still, he has warned that a soft landing is not assured.

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“It will be challenging, it won’t be easy. No one here thinks that it will be easy. Nevertheless, we think there are pathways … for us to get there,” Powell said during an interview last week with Marketplace.

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