The worst of inflation could be behind us. A recession may not be

The writing was on the wall for a recession in 2023.

At this time last year, sky-high inflation was barely budging, leaving the Federal Reserve with no choice but to continue hiking interest rates. The S&P 500 was well into a bear market. Layoffs, especially in tech, were piling up as companies cut costs.

And to top it all off, the Philadelphia Phillies made it to the World Series — a historically terrible sign for the economy since a recession kicks off each time the team wins.

But the Phillies’ eventual loss to the Houston Astros last year was apparently the economy’s gain because a recession never happened.

Truth be told, the reasons why it didn’t come to be in 2023 have little to do with baseball and more to do with good policies and a bit of luck.

Still, as the standard investment disclaimer goes, past performance is no guarantee of future results.

The case for a recession in 2024

The risk of a recession has been elevated since the Fed began its tightening cycle in March 2022, Fed Chair Jerome Powell told reporters in December. However, he said that “there’s little basis for thinking that the economy is in a recession now.”

But even when the economy seems as though it has never been in better shape, there’s always the possibility of a recession in the next year, Powell added.

That’s because unforeseen economic shocks — like, say, a global pandemic — can arise at any point.

Barring future unexpected events, some economists think present conditions still have the potential to usher in a recession in the coming year.

“The recession is just delayed, but not completely removed,” said Kathy Bostjancic, chief economist at Nationwide Mutual.

One metric Bostjancic has been keeping close tabs on is employment in the private services sector, excluding health and education. The remaining sectors within private services — such as transportation and leisure and hospitality — are more cyclical, meaning they are more vulnerable to economic downturns. So studying movements in that sector gives her a better sense of the state of the economy, she said.

In November 2022, monthly hiring in the private services sector excluding health and education equaled 92,000, according to Labor Department data. However, the November 2023 jobs report shows a steep drop, with 22,000 new hires in the sector.

Overall, job growth has been solid over the past year, which has helped keep the unemployment rate below 4%.

Bostjancic isn’t convinced that will carry over into the new year, though. She thinks there’s a 65% chance of a mild recession in 2024 and predicts the unemployment rate will rise to 5% by the third quarter. That’s almost a percentage point higher than Fed officials’ median projection for the unemployment rate in 2024, according to the latest Summary of Economic Projections.

The income drop from the unemployment Bostjancic is predicting would likely cause consumers to pull back on spending and give rise to a recession, she told CNN. And unlike the past few years, consumers don’t have “any extra fuel” to tap in to because they’ve depleted savings they accumulated during the pandemic, she added.

There’s also a recession risk stemming from the Fed itself. That’s because the central bank’s current high level of interest rates is intended to slow the economy to help bring inflation closer to its 2% target.

But if inflation continues to recede and the Fed waits too long to cut interest rates, it could prevent the economy from growing, said Louise Sheiner, a senior fellow at the Brookings Institution and the policy director for the Hutchins Center on Fiscal and Monetary Policy.

That means it’s going to be challenging for the Fed to determine when it makes sense to cut interest rates, if at all.

For instance, Sheiner said because it takes a while for interest rates to spread through the economy, the Fed’s prior actions could already be slowing the economy enough to get inflation near the target even though it hasn’t shown up in data yet. If the Fed leaves interest rates unchanged, it could end up overshooting and causing a recession “by mistake.”

On the other hand, there’s also the danger that inflation becomes much harder to fight.

If the Fed wants everyone to believe it’s committed to getting inflation down to 2%, it will “have to engineer a slowdown,” Sheiner told CNN.

That could mean keeping rates higher for longer than investors are currently anticipating, or even raising interest rates.

The case for another year without a recession

It’s not completely out of the question for the Fed to achieve a soft landing, a term used to describe a scenario when inflation cools without a major spike in unemployment.

Through the 11 rate-hiking cycles in the past 60 years that were aimed at bringing down inflation, that’s only happened a few times — in 1964, 1984 and 1994. But that doesn’t mean it can’t or won’t happen again.

View this interactive content on CNN.com

David Mericle, chief US economist at Goldman Sachs, is one of the believers in a soft landing.

“The hard part of the inflation fight now looks over,” he wrote in a November note, adding that “the conditions for inflation to return to target are in place, and the heaviest blows from monetary and fiscal tightening are well behind us.”

While there was “good reason to worry” about a recession last year, he said, he doesn’t “see any particularly elevated risks at the moment.”

With the unemployment rate hovering around historically low levels and millions of jobs still up for grabs, “it would be surprising if we were to have a sudden deterioration in the labor market,” Mericle told CNN.

His team sees only a 15% chance of a recession in the next 12 months. He referred to that as the “historical unconditional average,” meaning that in any given year he believes there’s a minimum 15% chance of a recession. But when inflation was near its peak during the banking turmoil that kicked off in March 2023, Goldman Sachs economists saw a 35% chance of a recession in the next 12 months.

They lowered their forecasts beginning in June as inflation continued to improve, the labor market got more balanced and banking stress dissipated.

While Mericle doesn’t see any “obvious” trigger for a recession, he said it would likely be “some kind of unforeseen shock to the economy.”