El-Erian Sees Increased Recession Risk, One Fed Rate Cut

Summary

The conversation discusses the growing risk of economic slowdown, highlighting the potential impact of tariffs on global supply chains and inflation. Mohamed, an economic expert, predicts a likely revision of the U.S. GDP forecast downward and acknowledges the increasing probability of a recession. He emphasizes the uncertainty surrounding inflation and growth, advising caution. The discussion also touches on the role of the Federal Reserve, investor behavior, and the potential impact of the new administration’s fiscal policies on the economy. Mohamed concludes with a view on the challenges of maintaining U.S. exceptionalism amid these uncertainties.

Takeaways

• 😀 The potential for a tit-for-tat tariff war is a growing concern, with risks to global supply chains and economic growth.
• 😀 Economic growth expectations for the U.S. in 2025 may be revised down from 4.2% to a range of 2.3%, with potential downward revisions of up to 1%.
• 😀 There's an increased probability of a U.S. recession, now estimated at 25-30%, but it remains a risk scenario, not the baseline.
• 😀 The U.S. economy is facing high uncertainty, with fluctuating inflation and growth outcomes, leading to a cautious business outlook.
• 😀 Investors are still inclined to buy on market dips due to long-standing behavioral bias, even in the face of uncertain conditions.
• 😀 The probability of a rate cut by the Federal Reserve has risen, with markets pricing in multiple cuts, though a single cut seems more likely.
• 😀 Inflation risks are being overlooked, as some inflation indicators, like the 'prices paid' component in manufacturing, have shown significant increases.
• 😀 Companies are reacting quicker to price changes and inflation, and the second round effects of inflation could manifest sooner than expected.
• 😀 While the current administration has made strides in reducing energy prices and pushing for deregulation, its policies might face challenges from public sentiment and business confidence.
• 😀 U.S. exceptionalism is on pause, with potential risks, but the idea of revitalizing it through tax reforms and deregulation could reignite business confidence, provided the journey to that outcome is well-managed.

Q & A

What is the current economic outlook for the U.S. in 2025 according to Mohamed?

Mohamed expects that the U.S. economy, which had a strong performance in 2024, will experience a downward revision for 2025. Growth projections may drop from 4.2% to around 2.3%. This slowdown could lead to a scenario of 'stall speed,' where the economy is not growing fast enough to avoid more significant problems.

What does Mohamed mean by 'stall speed' in the context of the economy?

'Stall speed' refers to a situation where the economy is growing too slowly to gain the momentum needed to avoid a downturn or recession. It implies that the economy is struggling to keep up enough growth to maintain a stable and healthy state.

Has the probability of a U.S. recession increased, and if so, by how much?

Yes, Mohamed has increased the probability of a recession from 10% at the beginning of the year to between 25% and 30%. This is considered a risk scenario, not a baseline expectation, due to the uncertainty surrounding growth and inflation.

What uncertainty factors are causing concern in the current economic climate?

The uncertainty stems from the unpredictability of both growth and inflation outcomes. Many factors are in play, and this unpredictability is causing hesitation among businesses, which could lead to a slowdown if they hold off on making decisions.

Why did the equity market reverse its recent downturn, according to Mohamed?

The equity market reversed its downturn because investors are conditioned to 'buy on the dips,' a strategy that has been successful in the past. This behavior is deeply ingrained, and it takes more than a short-term sell-off to make investors abandon this approach.

Does Mohamed believe that the market's expectation of three rate cuts is realistic?

No, Mohamed believes that the market's expectation of three interest rate cuts is excessive. He suggests that there is a higher likelihood of only one rate cut, as inflation risks are still present and may prevent the Federal Reserve from acting as aggressively as the market expects.

What inflationary signals does Mohamed point to as concerning?

Mohamed points to rising inflationary pressures, particularly in the 'prices paid' component of the ISM manufacturing survey, which increased by seven points. He also highlights surveys showing expectations of higher inflation, suggesting that inflation risks are not yet under control.

What is Mohamed's view on the fiscal policies being pursued by the administration?

Mohamed acknowledges that some fiscal policies, like reducing energy prices and pursuing public sector reforms, could benefit the economy in the long term. However, he also expresses concern about short-term disruptions caused by these policies, particularly in terms of higher taxation or other fiscal measures.

How does Mohamed see the potential for U.S. exceptionalism moving forward?

Mohamed believes that U.S. exceptionalism is on pause. While it is not completely gone, there are significant risks to it, especially due to the uncertainty in the economy. If pro-business policies like deregulation and tax reform are implemented successfully, there could be a chance to reignite U.S. exceptionalism.

What role does household and business sentiment play in the economic outlook?

Sentiment among businesses and households is crucial. If negative sentiment continues, it could further weaken the economy. Both households and businesses need to feel confident in their financial outlook to drive spending and investment, which is key to economic recovery. A decline in sentiment could make the administration's tasks even more difficult.