Washington: 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, most economists do not anticipate a recession in the near future. 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 still booming, with strong layoffs, fewer layoffs and many employers eager for more workers.
“Nothing in the US data is currently indicating a recession,” Rubila Farooqui, chief US economist for High Frequency Economics, wrote on Tuesday. “Job growth remains strong and households are still spending.
That said, Farooqui cautioned, “the economy is facing adversity.”
Signs that recession risks are mounting: High inflation has proved far stronger and more persistent than many economists – and the Fed had expected: Consumer prices rose 8.6% last month compared to a year ago, Russia’s invasion of Ukraine has pushed up global food and energy prices, the biggest annual 12-month jump since 1981. The extreme lockdown in China over COVID-19 exacerbated the supply shortage.
Fed Chairman Jerome Powell has vowed to do whatever it can 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.
On Wednesday, the Fed is set to raise its benchmark interest rate, affecting many consumer and business loans, by more than three-quarters of a percentage point. This would be the Fed’s biggest rate hike since 1994, and it could herald a period of particularly aggressive credit tightening by the central bank — and with it, a higher risk of recession.
Analysts say the US economy, which has thrived for years on fuels of very low borrowing costs, may not be able to cope with the impact of very high rates.
The country’s unemployment rate is at a nearly half-century low of 3.6%, and employers are posting a nearly record number of open jobs. Yet even an economy with a healthy labor market may eventually face a recession if borrowing becomes expensive and consumers and businesses put the brakes on spending.
How will the economy weaken due to the Fed’s rate hike?
Higher lending rates are sure to slow spending in areas where consumers need to borrow, with housing being the most visible example. The average rate on a 30-year term mortgage topped 5% in April for the first time in a decade and has remained there ever since. A year ago, the average was below 3%.
Home sales have fallen in response. And so are 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.
How is the cost affected?
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. 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.
Does a sinking stock market hurt the economy?
Falling stock prices can discourage affluent families, who collectively hold the bulk of America’s stock wealth, from spending it on vacation travel, home renovations or new equipment. Broad stock indices have fallen for weeks. Falling share prices also reduce corporations’ ability to expand. 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. Eventually, with economic growth slowing as well as layoffs increasing, the recession will fill in on its own, forcing consumers to hold back from worrying that they, too, may lose their jobs.
What are the signs of an impending recession?
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 percentage point over the past three months means a recession will eventually follow.
Any other pointers to watch?
Many economists also monitor changes in interest payments, or yields, on individual bonds for signs of a recession, known as the “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.
Inverted yield curves generally mean investors anticipate a recession will force the Fed to cut 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 short-term reversal occurred on Tuesday, when the yield on the two-year Treasury briefly fell below the 10-year yield as it temporarily did in April. However, many analysts say that comparing 3-month yields to 10-year ones has a better track record of recession-prediction. Those rates are no longer reversing.
Powell has said that 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 have to raise wages as much, thereby easing inflationary pressures, but without significant job losses or outright recessions.
“I expect it to be very challenging,” Powell said. ‘It’s not going to be easy.’
While economists say it is possible for the Fed to succeed, most now also say they doubt the central bank can eventually contain inflation so high without derailing the economy.
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, many economists say any slowdown will 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.
Associated Press Economics writer Paul Wiseman contributed to this report.
