The 2024 Economic Tightrope Walk: A peek into the world’s not-so-super superpower

Heading into 2023, the world’s largest economy found itself staring down a long spiral of recession. The ominous predictions were nearly unanimous. As the year came to a close, the forecasted economic downturn did not arrive. With the dawn of 2024, economists have become increasingly optimistic that the  economy will achieve a soft landing, gently slowing rather than screeching to a halt. Wells Fargo joined the likes of JPMorgan Chase and other big banks to withdraw their predictions of a recession. Yet if forecasters were wrong when they predicted a recession last year, they could be wrong again, this time in the opposite direction. 

The risks that economists highlighted in 2023 haven’t gone away, and recent economic data, though still mostly positive, has suggested some cracks beneath the surface. Economists have highlighted signs of weakness in the labor market. Hiring has slowed, with only a few industries accounting for the majority of recent employment increases. 

If a recession does arrive, economists say that there are three main ways that could happen:

1. The Delayed Slowdown

The primary reason economists predicted a recession last year was that they expected the Fed to cause one. Fed policymakers have spent the last two years attempting to contain inflation by raising interest rates at the fastest pace in decades. The idea was to reduce demand just enough to lower inflation without causing mass layoffs. Most forecasts — including many inside the central bank — feared that such a fine calibration would prove too tough and that once consumers and businesses began to draw back, a recession was all but unavoidable. 

It is still possible that their analysis was right and that only the timing was wrong. It takes time for the effects of higher interest rates to flow through the economy. Many corporations, for example, refinanced their debt during the period of ultralow interest rates in 2020 and 2021; only when they need to refinance again will they feel the pinch of increasing borrowing prices. Many families were able to withstand higher interest rates because they had saved or paid off obligations prior to the pandemic.

Those buffers are eroding, however. The extra savings are dwindling or already gone, according to most estimates, and credit card borrowing is setting records. Higher mortgage rates have slowed the housing market. Student loan payments, which were paused for years during the pandemic, have resumed. State and local governments are reducing their budgets as federal aid dries up and tax revenue falls.

2. The Return of Inflation

The sharp decline in inflation is the main factor behind experts' increased optimism on the likelihood of a soft landing. Shorter-term indicators show that inflation is currently just marginally above the Fed's long-term 2 percent target. Policymakers have greater flexibility when inflation is under control, which enables them to lower interest rates in the event that, for example, unemployment starts to increase. However, if inflation increases once more, authorities might find themselves in a tight spot and unable to lower interest rates if the economy weakens. Worse, they might even be compelled to think about raising rates once more.

Inflation fell in 2023 partly because the supply side of the economy improved significantly, after the disruptions caused by the pandemic. Few people expect a similar supply resurgence in 2024, however. That means that for inflation to keep falling, it may require a slowdown in demand. If the sufficiently tight financial conditions are not maintained, there is a risk that inflation will pick back up and reverse the progress made, leaving the door open for a recession.

3. The Unwelcome Surprise

The economy caught some lucky breaks last year. The Congress narrowly avoided a government shutdown with minimal drama, the Chinese economy’s slow recovery helped hold commodity prices in check, and the Middle East conflict's outbreak had little impact on world oil prices.

But by 2024, this good fortune might run out, right? Red Sea shipping lines are being disrupted by the Middle East's growing turmoil. The Congress will face another government-funding deadline in March Furthermore, new dangers might materialize, such as a deadlier coronavirus strain, hostilities across the Taiwan Strait, or a catastrophe in a hitherto undiscovered area of the financial system.

Any of those scenarios could throw off the delicate balance that the Fed is attempting to strike by resulting in either a decline in demand, an increase in inflation, or both. The Fed has minimal leeway in error, even though these risks are constantly present. There is less of a safety net in case growth is further hampered by the economy's notable slowdown. But with inflation still elevated — and memories of high inflation still fresh — the Fed could have a hard time ignoring even a temporary spike in prices.