As deep-seated problems in the US economy become apparent, Wall Street believes the likelihood of a recession is rising.
2026-03-26 10:32:47
When asked last week whether stagflation posed a threat to the U.S. economy, Federal Reserve Chairman Jerome Powell explicitly denied it. However, with Wall Street economists significantly raising the probability of a U.S. recession due to the war in Iran and potential high inflationary pressures, his successor may face even more difficult policy challenges.
In recent days, economists have raised their assessments of the risk of a U.S. economic contraction due to a significant increase in geopolitical risks and continued pressure on the U.S. labor market over the past year.
Moody's Analytics has raised its estimate of a U.S. recession in the next 12 months to 48.6%. Goldman Sachs has increased that probability to 30%, Wilmington Trust estimates it at 45%, and EY Parthenon estimates it at 40%, noting that "these probabilities could rise rapidly if the Middle East conflict lasts longer or becomes more severe."
In normal times, the baseline risk of a recession within the next 12 months is about 20%. While current projections are far from certain, they clearly reflect a significant increase in the level of risk.
This situation presents a significant challenge for policymakers, who need to strike a balance between threats to the labor market and persistent inflationary pressures.
"I'm concerned that the risk of recession is currently at an alarmingly high level and continues to rise . A recession has become a real threat here," said Mark Zandi, chief economist at Moody's Analytics.
As the war with Iran continues to drag on, discussions about a potential contraction in the U.S. economy have increased significantly.
Since the Great Depression, almost every economic recession in the United States has been preceded by an oil shock (except during the COVID-19 pandemic).
According to AAA data, U.S. gasoline prices rose by $1.02 per gallon over the past month, an increase of 35%. While economists are still debating the transmission effects of rising energy prices, historical patterns show that this trend is highly persistent.
Mark Zandi points out: "The negative effects of high oil prices tend to come earliest and fastest. If oil prices remain at current levels until Memorial Day, or even the end of the second quarter, we could very well fall into a recession ."
Like most forecasters, Zandi also stated that his "baseline scenario" remains that the warring parties will find a diplomatic way out and oil flows will resume in the Strait of Hormuz, thus preventing the U.S. economy from suffering the worst-case scenario.
Besides energy prices, economists believe the labor market is another key stressor.
The US is projected to add only 116,000 jobs in 2025, with a net loss of 92,000 jobs in February alone. While the unemployment rate remains stable at 4.4%, this is primarily due to fewer layoffs by companies, rather than a significant increase in hiring.
Furthermore, the breadth of recruitment in the labor market is extremely narrow. Excluding the more than 700,000 new jobs added in the healthcare sector, employment in other industries actually decreased by more than 500,000 over the past year.
"I think the risks to inflation are much lower than Fed officials believe, while the downside risks to the labor market are much higher than they have stated," said Luke Tilley, chief economist at Wilmington Trust.
Dan North, senior U.S. economist at Allianz Group, added, "The population that needs more healthcare will continue to grow, and this demand for employment will persist. But if the entire economy relies on only one engine, that is not sustainable."
Employment is a key driver of consumption. Despite rising prices and concerns about economic growth, U.S. consumer spending has remained relatively strong so far.
The aforementioned dual pressures have sparked discussions in the market about "stagflation," a situation where high inflation and slowing economic growth occur simultaneously, which caused serious problems in the United States in the 1970s and early 1980s.
At the press conference following last week's Federal Reserve policy meeting, Powell explicitly refused to use the term "stagflation." At that time, the Fed decided to maintain the benchmark interest rate in the range of 3.5% to 3.75%.
Powell said, "I must point out that stagflation is a term from the 1970s, when unemployment was in double digits and inflation was very high. The situation is completely different now."
He added, “The current situation is indeed very difficult, but it is completely different from the situation in the 1970s… I reserve the term ‘stagflation’ for that period. Perhaps this is just my personal opinion.”
The current state of the US economy may be described as "mild stagflation," less severe than in the 1970s, but it still poses significant risks. Consumer confidence remains weak overall, with low- and middle-income groups bearing particular pressure due to high prices.
Luke Tilley of Wilmington Trust warned that recent consumer growth has largely relied on the wealth effect from rising asset prices, a dynamic that may be unsustainable.
He said, "We estimate that 20% to 25% of the consumption growth over the past two years has come from the wealth effect generated by the stock market. If this wealth effect is lost, economic growth will decline sharply ."
In fact, U.S. stocks have performed poorly since the outbreak of the war. The Dow Jones Industrial Average has fallen by more than 5% during the conflict. This has put pressure on consumption and confidence, as higher-income groups are the biggest beneficiaries of the stock market rally, and their consumption has a significant impact on the overall economy.
According to the Atlanta Fed's GDPNow model, U.S. GDP growth in the first quarter is projected at 2%, but this is based on a low base of only 0.7% growth in the fourth quarter of 2025 (partly due to the government shutdown). Economists had expected the drag from the fourth quarter to be offset in the first quarter, but the actual effect appears to be limited.
However, if global leaders can end this conflict soon, the US economy still has a chance to avoid the most pessimistic forecasts. A comprehensive beauty package, expected to be passed in 2025, is anticipated to stimulate economic growth, including reducing regulatory burdens and increasing tax rebates to help consumers cope with high prices. Furthermore, a continued recovery in production activity is also a favorable factor for the economy.
Allianz economist Dan North said, "The economic fundamentals remain supported, which makes me very cautious about using the word 'recession.' But I do think the U.S. economy is clearly slowing down this year."
Federal Reserve Chairman Jerome Powell continues to deny the risk of stagflation, but Wall Street forecasters have significantly raised their recession probability, reflecting the combined geopolitical uncertainty stemming from the Iran war and a weak domestic labor market posing a substantial threat. Whether the US economy can achieve a soft landing will depend on the duration of the Middle East conflict, oil price trends, and the Fed's ability to balance inflation and employment policies.
For investors, caution is advised at this time, paying attention to both the Federal Reserve's policy signals and closely monitoring the latest developments in the Middle East.
Economists significantly raise their recession risk assessment
In recent days, economists have raised their assessments of the risk of a U.S. economic contraction due to a significant increase in geopolitical risks and continued pressure on the U.S. labor market over the past year.
Moody's Analytics has raised its estimate of a U.S. recession in the next 12 months to 48.6%. Goldman Sachs has increased that probability to 30%, Wilmington Trust estimates it at 45%, and EY Parthenon estimates it at 40%, noting that "these probabilities could rise rapidly if the Middle East conflict lasts longer or becomes more severe."
In normal times, the baseline risk of a recession within the next 12 months is about 20%. While current projections are far from certain, they clearly reflect a significant increase in the level of risk.
This situation presents a significant challenge for policymakers, who need to strike a balance between threats to the labor market and persistent inflationary pressures.
"I'm concerned that the risk of recession is currently at an alarmingly high level and continues to rise . A recession has become a real threat here," said Mark Zandi, chief economist at Moody's Analytics.
War was the main driving force
As the war with Iran continues to drag on, discussions about a potential contraction in the U.S. economy have increased significantly.
Since the Great Depression, almost every economic recession in the United States has been preceded by an oil shock (except during the COVID-19 pandemic).
According to AAA data, U.S. gasoline prices rose by $1.02 per gallon over the past month, an increase of 35%. While economists are still debating the transmission effects of rising energy prices, historical patterns show that this trend is highly persistent.
Mark Zandi points out: "The negative effects of high oil prices tend to come earliest and fastest. If oil prices remain at current levels until Memorial Day, or even the end of the second quarter, we could very well fall into a recession ."
Like most forecasters, Zandi also stated that his "baseline scenario" remains that the warring parties will find a diplomatic way out and oil flows will resume in the Strait of Hormuz, thus preventing the U.S. economy from suffering the worst-case scenario.
Risk of exacerbated weakness in the labor market
Besides energy prices, economists believe the labor market is another key stressor.
The US is projected to add only 116,000 jobs in 2025, with a net loss of 92,000 jobs in February alone. While the unemployment rate remains stable at 4.4%, this is primarily due to fewer layoffs by companies, rather than a significant increase in hiring.
Furthermore, the breadth of recruitment in the labor market is extremely narrow. Excluding the more than 700,000 new jobs added in the healthcare sector, employment in other industries actually decreased by more than 500,000 over the past year.
"I think the risks to inflation are much lower than Fed officials believe, while the downside risks to the labor market are much higher than they have stated," said Luke Tilley, chief economist at Wilmington Trust.
Dan North, senior U.S. economist at Allianz Group, added, "The population that needs more healthcare will continue to grow, and this demand for employment will persist. But if the entire economy relies on only one engine, that is not sustainable."
Employment is a key driver of consumption. Despite rising prices and concerns about economic growth, U.S. consumer spending has remained relatively strong so far.
The shadow of stagflation has reappeared, but Powell firmly denies it.
The aforementioned dual pressures have sparked discussions in the market about "stagflation," a situation where high inflation and slowing economic growth occur simultaneously, which caused serious problems in the United States in the 1970s and early 1980s.
At the press conference following last week's Federal Reserve policy meeting, Powell explicitly refused to use the term "stagflation." At that time, the Fed decided to maintain the benchmark interest rate in the range of 3.5% to 3.75%.
Powell said, "I must point out that stagflation is a term from the 1970s, when unemployment was in double digits and inflation was very high. The situation is completely different now."
He added, “The current situation is indeed very difficult, but it is completely different from the situation in the 1970s… I reserve the term ‘stagflation’ for that period. Perhaps this is just my personal opinion.”
Cracks appear in the foundation of consumption
The current state of the US economy may be described as "mild stagflation," less severe than in the 1970s, but it still poses significant risks. Consumer confidence remains weak overall, with low- and middle-income groups bearing particular pressure due to high prices.
Luke Tilley of Wilmington Trust warned that recent consumer growth has largely relied on the wealth effect from rising asset prices, a dynamic that may be unsustainable.
He said, "We estimate that 20% to 25% of the consumption growth over the past two years has come from the wealth effect generated by the stock market. If this wealth effect is lost, economic growth will decline sharply ."
In fact, U.S. stocks have performed poorly since the outbreak of the war. The Dow Jones Industrial Average has fallen by more than 5% during the conflict. This has put pressure on consumption and confidence, as higher-income groups are the biggest beneficiaries of the stock market rally, and their consumption has a significant impact on the overall economy.
According to the Atlanta Fed's GDPNow model, U.S. GDP growth in the first quarter is projected at 2%, but this is based on a low base of only 0.7% growth in the fourth quarter of 2025 (partly due to the government shutdown). Economists had expected the drag from the fourth quarter to be offset in the first quarter, but the actual effect appears to be limited.
If the war ends quickly, the economy still has a chance to avoid the worst outcome.
However, if global leaders can end this conflict soon, the US economy still has a chance to avoid the most pessimistic forecasts. A comprehensive beauty package, expected to be passed in 2025, is anticipated to stimulate economic growth, including reducing regulatory burdens and increasing tax rebates to help consumers cope with high prices. Furthermore, a continued recovery in production activity is also a favorable factor for the economy.
Allianz economist Dan North said, "The economic fundamentals remain supported, which makes me very cautious about using the word 'recession.' But I do think the U.S. economy is clearly slowing down this year."
Overall Outlook
Federal Reserve Chairman Jerome Powell continues to deny the risk of stagflation, but Wall Street forecasters have significantly raised their recession probability, reflecting the combined geopolitical uncertainty stemming from the Iran war and a weak domestic labor market posing a substantial threat. Whether the US economy can achieve a soft landing will depend on the duration of the Middle East conflict, oil price trends, and the Fed's ability to balance inflation and employment policies.
For investors, caution is advised at this time, paying attention to both the Federal Reserve's policy signals and closely monitoring the latest developments in the Middle East.
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