- The wheels of the next recession have been irreversibly set in motion by the Federal Reserve, according to David Rosenberg, the founder of Rosenberg Research and Associates.
- Rosenberg was previously the chief economist of Merrill Lynch and Gluskin Sheff.
- In a conversation with "The Sherman Show," a DoubleLine Capital podcast, he said the Fed's balance sheet reduction and interest rate hikes have tightened monetary conditions to levels that are consistent with previous economic downturns .
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When the Canadian economist David Rosenberg described the odds of the next US recession, a French expression came to mind: "les jeux sont faits."
It loosely translates to "the bets are made," and it's a gambling reference to when the roulette wheel is spinning.
What Rosenberg means is that the Federal Reserve has irreversibly set the wheels of the next economic downturn in motion, he explained on a podcast this month. Rosenberg recently left Gluskin Sheff to start his own firm, Rosenberg Research and Associates.
"We actually had a monetary policy shock," Rosenberg recently said on "The Sherman Show," a DoubleLine Capital podcast.
He was referring to the Fed's nine interest-rate hikes between 2015 and 2018, implemented to normalize policy after years of emergency measures spurred by the Great Recession.
The Fed has also been reducing the assets it held on its balance sheet. By Rosenberg's estimation, the net impact of the balance sheet reduction was the equivalent of adding roughly 400 basis points (or 4%) to the changes the Fed made to its funds rate.
Rosenberg has previously noted that the Fed raised rates by as much as 400 basis points in the lead up to the 2008 and 1990 recessions.
"What if I told you that historically, when the Fed engaged in a 400 basis point-plus tightening cycle, the odds of recession in the next 12 to 24 months was 80%," Rosenberg said.
"I'm not saying the next three, six, [or] 12 months. But you know that it's out there and you know what the odds are."
To be sure, more recently the Fed has cut its interest rate three times, and it now stands at a range of 1.75% to 2%.
Rosenberg further highlighted the New York Fed's recession probability model, which jumped last summer to its highest level since the financial crisis. This spike was due to the yield-curve inversion, which occurred when the 10-year Treasury yield unusually fell below its 2-year counterpart.
"Usually at the time of recession, the yield curve's already re-steepened because the Fed's cut rates," Rosenberg said. "But it's too late. The damage has been done."
A mild recession
The next economic recession will likely be mild because there are insufficient economic imbalances like a housing crisis to cause a severe downturn, Rosenberg said. What he sees are financial-market imbalances that remind him of the 2000 dot-com bust and 2001 recession.
"I don't think that the recession is going to be measured so much by magnitude or peak-to-trough decline in economic activity," Rosenberg said. "I expect it's going to be mild in that respect."
However, getting out of the recession could be difficult because "we don't have the traditional bullets," he added.
He noted the US government's deficit, which swelled to nearly $1 trillion in 2019 despite a robust economy. If fiscal stimulus and even more deficit expansion is deployed to combat the next recession, they will face the so-called law of diminishing returns and have a small impact on growth, Rosenberg said.
"I don't want to sound overly bearish here, but I do want to say that you want to be prepared for a pretty rough year - or to say it politely, a challenging year for economic growth," Rosenberg said.