Although many economists and financial experts started the year forecasting that 2022 would be the year that the U.S. put supply-chain issues in the rearview mirror and produced another strong four quarters of economic growth, those hit the wall in February when Russia invaded Ukraine and inflation continued to spiral upward. Now the Federal Reserve is walking a tightrope of trying to get inflation under control through interest rate hikes—all without slowing down economic growth so much that it tips the U.S. into a recession.

Since January 2021, one economist in particular has gotten cited repeatedly by the Biden administration, and he doesn’t even work in the White House. That’s Mark Zandi, Moody’s chief economist, and even he is worried about a recession in the next two years, although that’s not quite the full story.

On Tuesday, Zandi noted that he believes there’s about a 35% probability that the U.S. will enter a recession in the next two years, but he sees bigger potential for something else. 

“The risk of the economy entering into a recession at some point over the next 12, 18, 24 months is very high, uncomfortably high. And I’d say [it’s] rising,” Zandi said Tuesday during a webinar. That’s on par with Goldman Sachs’ recent estimate, which also put the likelihood of a recession at 35%. If the U.S. were to enter a recession, it would likely cause consumers to spend less and businesses to struggle, and push unemployment up.

After the inversion

Zandi’s analysis comes after the bond market’s yield curve inverted in late March. Typically, yields for shorter-term U.S. Treasuries are lower than those with longer maturity dates. A yield curve inversion happens when two-year U.S. Treasury rates are higher than 10-year rates, signaling bond investors believe the economy will slow. (It’s a standard predictor of a recession.) 

The recent yield curve inversion—which has been as used as a bellwether for upcoming recessions—raised a lot of concern about the potential for the Federal Reserve “stepping too hard on the brakes here to quell inflation,” Zandi says.  

But while the Fed arguably has a difficult road ahead in curbing inflation while maintaining low unemployment and stable economic growth, Zandi believes the U.S. central bank will be able to do it. “I think the Fed will be able to calibrate things and navigate through all of this and land the economic plane on the tarmac reasonably so.”

Rather than a recession, Zandi says the most probable outcome is that the economy will evolve into what’s called a “self-sustaining economic expansion,” in which the U.S. will be back to full employment and the sky-high inflation levels retreat. He said there’s about a 50% chance of this scenario playing out. 

In fact, Zandi said he believes inflation—which the consumer price index (CPI) clocked at 8.5% in March—is close to peaking. “Obviously, 8.5% year over year through March is very high. I expect that to moderate significantly,” he said, adding that by the end of this year he expects CPI inflation of about 5%. Further, he predicts U.S. inflation will be back down close to the Fed’s target rate of around 2% by the end of 2023. 

“I am in the view that the surge in inflation that we’ve suffered over the past year is largely the result of supply-side shocks to the economy,” Zandi said. The two obvious ones: the pandemic and the Russian invasion of Ukraine. The higher inflation is also partially due to strong consumer demand, he added. 

Zandi’s predictions around inflation falling, however, are based on the assumption that the pandemic continues to wind down and that the supply-chain issues iron out. Additionally, Zandi said, his other big assumption is that the impact of the Russian invasion—and its fallout on oil, natural gas, and other prices—is at its peak right now. 

He also believes that broadly speaking, aside from inflation, the U.S. economy is in a pretty good place fundamentally. “There aren’t those major imbalances in the economy that tend to do the economy in when they go off the rails,” Zandi said. 

Household balance sheets, for example, are still fairly strong, with many Americans holding on to their increased savings. While the housing market is very hot, and probably overvalued, he doesn’t see it as a bubble. Same with stocks—likely overvalued, but not heading for a crash. 

Cryptocurrencies, on the other hand, Zandi sees as potentially being in bubble territory, but the market for these are relatively small at the moment, so even if there’s a crash, it’s unlikely to have a major impact on the U.S. economy. 

But despite Zandi’s view that the U.S. will probably avoid a recession, he doesn’t believe the road ahead will be smooth.

“I don’t think I want to say soft landings or that anything about this is going to be soft. This is going to feel ugly—it’s already feeling ugly. So it’s not gonna be an easy thing. There’s going to be a lot of bumps, a lot of hand-wringing along the way. But I think we’re going to be able to land the plane.”