With the US having the largest economy in the world, a hard landing of the US economy will have widespread spillover effects globally. Since the pandemic and the war in Ukraine, the US economy has faced exceptional circumstances that give rise to the risk of a recession. The prospects of a hard landing have increased substantially this year as persistent inflation and low unemployment could prompt an even more restrictive monetary policy than previously expected. Meanwhile, sudden turmoil in the banking sector has added another layer of risk and uncertainty.
Main economic concern shifts from persistent inflation to financial instability
The likelihood of an earlier and deeper recession in the US increased significantly in the first quarter of 2023. First, inflation proved surprisingly sticky in January and February, driven primarily by a persistent imbalance between labour supply and demand that led to considerable gains in jobs and wages. This, in turn, fuelled an inflationary wage-price spiral as well as resilient consumer spending.
In the process, inflation became further entrenched in the economy, thereby putting pressure on the US Federal Reserve (Fed) to reaccelerate its monetary policy tightening in order to tame price pressures effectively. Then, on 8 March, the US saw the beginning of significant stress in the banking system, triggered in large part by the Fed’s fastest interest rate-hiking cycle since the 1980s, with the failure of Silvergate Bank, followed by the largest bank failure in the US since 2008 with Silicon Valley Bank on 10 March, and the failure of Signature Bank on 12 March.
This has sent shockwaves through the US financial system, and beyond, leading to high uncertainty about systemic risks, a widespread crisis of confidence and thereby additional instability. Consequently, priorities for the Fed have swiftly shifted from taming inflation towards stabilising the financial system, which ultimately drove the decision to increase interest rates by just 25 bps on 22 March.
The banking crisis has increased the likelihood of a US hard landing scenario
Following the failure of multiple regional US banks within a single week, prompt measures by US regulators in order to stabilise the banking sector helped prevent rapid contagion in the financial system. However, this banking crisis has severely shaken market confidence, most likely beyond the short term, and added further uncertainty about the direction of the economy.
The banking turmoil has severely shaken market confidence, and added further uncertainty about the direction of the US economy
Source: Euromonitor International
Most importantly, against this backdrop, banks are likely to reduce lending to preserve liquidity in case of surging withdrawals from depositors, as was the case at Silicon Valley Bank. In addition, lending by regional banks is expected to come under further pressure following announcements by regulators regarding tighter credit conditions and stricter capital standards. Since regional banks account for a substantial share of all lending in the US, a meaningful decline would significantly dampen economic activity and increase the likelihood of a US hard landing scenario.
The domestic and global implications of a US recession
In this US hard landing scenario, businesses will reduce investment and hiring while increasing layoffs, as tighter lending standards, rising borrowing costs and weakening demand put pressure on profit margins. At the same time, consumers will significantly cut back on spending amid persistent inflation, deteriorating income prospects and rapidly eroding pandemic-era excess savings. With consumer spending being the main driver of the US economy, this scenario will lead to a recession.
With the US as the largest economy globally, a hard landing scenario will have widespread spillover effects. Consequently, other major economies will also register a decline in real GDP growth in 2023 compared to the baseline, as will the global economy overall. In 2024, there will be a diverging trend with China already posting an increase compared to the baseline real GDP growth, while the US, the Eurozone and the global economy as a whole remain below baseline growth.
In terms of real GDP growth rates, the US hard landing scenario will tip both the US and the Eurozone into recession in 2023, with the US even remaining in a recession in 2024.
Under the US hard landing scenario, the global economy would grow by 1.7% in real terms in 2023, due to a recession in both the US and Eurozone
Source: Euromonitor International
The global economy will avoid a recession despite a further slowdown in growth. This is partly supported by the relatively steady real GDP growth in China. The economic resilience in China even amid the US hard landing scenario is supported by the country’s reopening in late 2022 following years of restrictive zero-COVID policies which generated significant excess savings and pent-up demand that will drive consumer spending.
Note: The US hard landing scenario assumes that private consumption and private sector investment in the US both decline by 5% during Jul-Dec 2023 compared to Jul-Dec 2022 (2012 prices).
For comparison, private consumption at 2012 prices declined by 2% in Jan-Jun 2009 compared to Jan-Jun 2008, at the height of the Global Financial Crisis (GFC) and by 4% in Jan-Jun 2020 compared to Jan-Jun 2019, at the height of the COVID-19 pandemic.
Private sector investment at 2012 prices declined by 18% in Jan-Jun 2009 compared to Jan-Jun 2008, at the height of the GFC and by 4% in Jan-Jun 2020 compared to Jan-Jun 2019, at the height of the COVID-19 pandemic.
Learn more about global economic trends in our report, Global Economic Forecasts: Q1 2023.