WASHINGTON ( Associated Press) – Inflation is at a 40-year high. Stock prices are sinking. The Federal Reserve is making borrowing too expensive. And the economy actually shrank in the first three months of this year.
Is the United States in danger of facing another recession just two years after it emerged from the previous recession?
For now, even the more pessimistic economists don’t expect a recession any time soon. Despite inflationary pressures, consumers – the economy’s primary driver – are still spending at a healthy pace. Businesses are investing in equipment and software, which reflects a positive outlook. And the job market is stronger than it has been in years, with strong hiring, layoffs narrowing down and many employers desperate for more workers.
Yet several worrying developments in recent weeks suggest that the risk of a recession may be on the rise. High inflation has proven to be more stubborn than many economists expected. Russia’s invasion of Ukraine has raised global food and energy prices. The extreme lockdown in China over COVID-19 is exacerbating the shortage of supplies.
And when Federal Reserve Chairman Jerome Powell spoke at a news conference last week, he reinforced the central bank’s determination to contain inflation, including raising interest rates so high as to weaken the economy. If that happens, the Fed could potentially trigger a recession, perhaps in the second half of next year, economists say.
By mid-2023, the Fed’s benchmark short-term rate, which affects many consumer and business loans, could reach levels not seen in 15 years. Analysts say the US economy, which has thrived for years on a fuel of ultra-low borrowing costs, may not be able to cope with the impact of very high rates.
“Recession risk is low now, but high in 2023 as inflation could force the Fed to increase unless it hurts,” Bank of America global economist Ethan Harris said in a note to customers.
The country’s unemployment rate is at a nearly half-century low of 3.6%, and employers are posting a record-high number of open jobs. So what could be causing an economy with such a healthy labor market to fall into recession?
Here’s what the path of the final recession could look like:
The Fed’s rate hike will certainly slow spending in areas where consumers need to borrow, with housing being the most visible example. The average rate on 30-year fixed mortgages has already gone up to 5.25%, the highest level since 2009. A year ago, the average was below 3%. Home sales have fallen in response, and so have mortgage applications, a sign that sales will continue to slow. For example, a similar trend may occur in other markets for cars, appliances and furniture.
Borrowing costs for businesses are rising, as reflected in the increased yield on corporate bonds. At some point, those high rates can undermine business investments. If companies hold back from buying new equipment or increasing capacity, they will also begin to slow hiring.
Falling stock prices may discourage affluent families, who collectively hold the bulk of America’s stock wealth, from spending on vacation travel, home renovations or new equipment. Broad stock indices have fallen for five consecutive weeks. Falling share prices also reduce corporations’ ability to expand.
An increasing caution among companies and consumers about spending independently could slow hiring or even lead to layoffs. If the economy loses jobs and the public becomes more fearful, consumers will hold back on spending.
– Consequences of high inflation will make this scenario worse. Wage growth adjusted for inflation would slow and leave Americans with even less purchasing power. Although a weakening economy will eventually drive inflation down, high prices may hinder consumer spending until then.
After all, with economic growth slowing as well as layoffs increasing, the recession will feed into itself, forcing consumers to hold back from worrying that they, too, may lose their jobs.
Economists say the most obvious signs of a recession will be a steady increase in job losses and a rise in unemployment. As a rule, an increase in the unemployment rate by an average of three-tenths of a percent over the past three months means a recession will eventually follow.
Many economists also monitor changes in interest payments, or yields, on individual bonds for signs of a recession, known as a . is referred to as “Inverted Yield Curve.” This occurs when the yield on a 10-year Treasury falls below the yield on a short-term Treasury, such as a 3-month T-bill. This is unusual, as longer-term bonds usually give investors a higher yield in exchange for tying up their money for a longer period.
Inverse yield curves generally mean that investors anticipate a recession and will force the Fed to slash rates. Inverted curves often predict a recession. However, it can take up to 18 or 24 months for a recession to occur after the yield curve has inverted.
A very brief reversal occurred last month, when the yield on the 2-year Treasury fell below the 10-year yield. Yet most economists underestimated it because it was short-lived. Many analysts also say that comparing 3-month yields to 10 years’ track record is better. Those rates are no longer close to reversing.
At his news conference last week, Powell said the Fed’s goal was to raise rates to cool borrowing and spending so that companies could reduce their large number of job openings. In turn, Powell hopes, companies will not raise wages as much, which will ease inflationary pressures, but without significant job losses or outright recessions.
“We have a good chance of a soft or soft-ish landing,” Powell said. “But I will say that I expect it to be very challenging. It’s not going to be easy.”
While economists say it is possible for the Fed to succeed, most also say they doubt that the central bank can eventually overcome such high inflation without derailing the economy.
“It’s never been done before,” said Peter Hooper, Deutsche Bank’s global head of economic research. “It will be remarkable if the Fed is able to achieve that.”
Economists at Deutsche Bank believe the Fed will need to raise its key rate to at least 3.6% by the middle of 2023, enough to cause a recession by the end of that year. Still, Hopper suggested that the recession would prove relatively mild, with unemployment rising to only 5%.
Karen Dinan, a Harvard economics professor and a former top economist at the Treasury Department, also said she thought the recession, if any, would be mild. American households are in a much better financial position than they were before the extended Great Recession of 2008-2009, when falling home prices and a loss of jobs ruined the finances of many households.
“Quite a lot more people have some financial cushion,” Diane said. “Even if it takes a recession to beat inflation, it probably won’t have to be deep or long.”