The U.S. is likely to experience a short and shallow recession in 2023 as the Fed works to bring inflation back down to 2%, says economist Nouriel Roubini.

The first factor that will likely tip the economy into a recession is even higher interest rates, as inflation has not come down as quickly as the Federal Reserve and other central banks had hoped. This, Roubini says, is primarily due to a tight labor market and wage growth.

The second is the U.S. government has not cut back on its expansionary fiscal policies, which are “still feeding demand and contributing to the persistence of inflation,” Roubini writes in an opinion piece published on Marketwatch.

As such, Roubini sees four consequences that will continue to dampen the U.S. economy and stocks:

1.)  Higher Interest rates. Despite investors prematurely celebrating an end to interest rate hikes, “the U.S. Federal Reserve, the European Central Bank, the Bank of England and most other major central banks will have to raise rates even more before they can pause,” says Roubini, chief economist at Atlas Capital Team.

“As they do, the economic slowdown will become more persistent, raising the risk of an economic contraction and new debt and banking stresses,” Roubini adds.

2.)  Geopolitical risks. Unexpected world events continue to come out of the blue, one of the latest being Wagner Group’s abortive overthrow of Moscow.

The world is currently experiencing heightened “instability, deglobalization and fragmentation,” says Roubini, professor emeritus of economics at New York University’s Stern School of Business.

China is another wild card, now that its recovery is losing steam, Roubini adds. Should China pursue aggressive stimulus policies, this will aggravate global inflation, he warns.

3.) Credit crisis risk. The banking crisis of 2023 was averted by preventing further bank runs beyond Silicon Valley Bank and First Republic Bank, thereby lessening the risk of a severe credit crunch, Roubini says.

However, other economists have warned that banks, which have high exposure to commercial real estate loans, could face a credit crunch since so many U.S. offices are still vacant post-COVID.

4.) Consumer and business sentiment risk. If a recession in the U.S. does materialize, Roubini says, consumer and business sentiment could erode, which in itself would worsen economic conditions.

If the Fed foresees a deeper recession ahead, it might permit inflation to remain “well-above 2%, rather than risk triggering a severe economic and financial crisis,” Roubini says.

Summing up these hazards, Roubini says the Fed faces a “trilemma”: achieving price stability, growth stability (no recession) and financial stability—all at once.

Stocks

Should either a shallow recession or a hard landing occur, U.S. and global stocks will undoubtedly decline, Roubini believes.

If the Fed and other central banks permit inflation to remain elevated instead of risking a recession, “the resulting increase in inflation expectations would drive up long-term bond yields and eventually hurt stock prices, owning to the higher discount factor that would be applied to dividends,” he says.

In sum, Roubini says the global economy does not appear headed for a hurricane. But—“we are still likely to encounter a tropical storm that could cause significant economic and financial damage.”