Exorbitant inflation. Rise in interest rates. Decline in real estate purchases.
Analysts are scrambling to digest a host of signals about the state of the US economy, which has emerged from a pandemic recession stronger than anyone could have expected.
This week, these alarming trends collided with another major data point showing that US gross domestic product shrank in the first quarter of 2022.
Still, many economists believe a formal recession – the economy reversing for two straight quarters – is not imminent.
“It’s noise, not a signal,” wrote Ian Shepherdson, chief economist at the Pantheon Macroeconomics research group, of the GDP data in a note to clients. “The economy is not falling into recession.”
That sentiment was echoed by Bill Adams, chief economist at Comerica Bank, who noted in a tweet that consumer spending, investment and job growth remain healthy.
Still, many Americans feel nervous. Among the signs: Searches for “recession” have exploded on Google this month.
“There are undoubtedly a lot of challenges for the US economy,” said James Knightley, chief international economist at financial services group ING. “You have a situation where households are feeling the pressure of rising fuel and food costs, and wages not necessarily keeping pace.”
Recent readings of consumer sentiment also suggest that many Americans are unsure where their financial future is headed. To complicate matters: The ultra-low interest rate environment that has dominated the US economy for years has come to an end, with the Federal Reserve set to raise its key rate next week for the second time in nearly two months.
As a result, while most economists are certain that growth will begin to slow in the coming months, there is debate about how severe the decline will be and what it all means for the average American.
“People are feeling cautious – and we’re just starting to get higher interest rates,” Knightley said. “It’s annoying for people.”
On Wednesday, the US Bureau of Economic Analysis reported that US gross domestic product, one of the broadest measures of growth observed by economists, fell 1.4%. GDP represents the market value of goods and services produced in a country during a given period.
Still, many economists were unimpressed with the negative direction of the data, saying it was mostly a quirk of technical factors in the way GDP is calculated.
In particular, the data was heavily impacted by a sharp increase in imports of goods, a sign that demand is actually still quite strong.
“Because there was a huge backlog of ships waiting to be unloaded in US ports, imports remained high in the first quarter,” said Bill Adams of Comerica, meaning America was in a trade deficit. “So that translated into a reduction in GDP, which meant that buyers were going to buy more foreign products and less American products.”
But there are other signals suggesting that all may not be well in the economy. At the end of March, a key feature of the bond market associated with recessions emerged. This is called an inverted yield curve. This is what happens when it becomes riskier to hold short-term bonds than to hold longer-term bonds.
According to the Federal Reserve Bank of San Francisco, inverted yield curves have preceded every recession since 1955, although it sometimes takes two years for an economic contraction to occur after an inversion.
Only once, in the 1960s, did the curve invert and a recession did not follow soon after.
On March 29, the yield curve inverted, meaning bond buyers decided that short-term risks to economic growth were rising relative to longer-term ones.
ING’s Knightley said that doesn’t entirely rule out a recession. “But it’s a flashing warning sign that we need to take seriously.”
Experts like Knightley worry that if the warning signal is correct, average Americans could begin to experience higher unemployment and slower wage growth, even if inflation begins to slow.
The steepening of the yield curve has characterized our economic environment in recent months.
Where will inflation go from here?
It is unclear when an inflation slowdown will occur, or how quickly. Some economists believe inflation peaked in March, when the consumer price index hit a 40-year high.
Still, many economists believe inflation will persist for some time. In a note to clients published this week, Bank of America said, “Recession risks are low now but high in 2023 as inflation could force the Fed to hike until it hurts.”
The bank refers to the Federal Reserve’s plan to raise interest rates to control inflation. The Fed has said it will raise the benchmark interest rate six more times this year, which means the cost of borrowing – to buy homes, cars, take out student loans and pay off credit card debt credit – will become more expensive.
“Every recession is different, but Fed hikes and commodity shocks have played a role in most recessions over the past few decades,” the bank wrote. “Currently, we are facing a modest version of both: a commodity shock resulting from the Russian-Ukrainian war and significant Fed tightening. much wider than inflation.”
At the moment, the bank said, the main “imbalances” in the economy are high spending on goods and what it called “a potentially overheated labor market.”
Right now, he says, inflation is weighing heavily on real consumer spending, which has grown just 2.4% year-on-year over the past three quarters. Despite this, the GDP data shows that spending is still strong, with a few exceptions. Mortgage applications have recently fallen to their lowest levels in the post-Covid era, largely due to rising interest rates.
But inflation could persist if aggregate consumer demand remains too strong, thanks to the hot labor market and the Covid crisis. lockdowns in China again affecting supply chains, Bank of America said.
“[Economic] the risks are high and should certainly be considered above average,” the bank said. “If inflation is stronger than expected or growth falls rapidly, a recession would become the base case scenario. But we are not there yet.”
How should households prepare for a possible recession?
Goldman Sachs chief economist Jan Hatzius stressed in an April 17 note to investors that household balance sheets are healthy.
“The net wealth/disposable household income ratio [is] currently at an all-time high,” Hatzius said, citing stock market highs for much of 2021 and the record amount of money people have saved during the pandemic. “The private sector as a whole [is] running a healthy financial surplus,” Hatzius said.
“This means that a slowdown in income growth due to a reduction in labor demand induced by monetary policy is less likely to force households to drastically cut spending,” Hatzius added. which means families will likely continue to enjoy the ability to spend money on anything. they need and want because their balance sheets are so healthy right now.
“It probably increases the chances of avoiding a recession,” he said.
So what can consumers do to prepare for a recession? Ironically, it’s the fear of a slowdown that can often trigger one.
“Planning for a recession is the perfect cocktail for ending up with a recession,” said Gregory Daco, chief economist at EY-Parthenon, Ernst & Young LLP. “So it often becomes a self-fulfilling prophecy: consumers start buying less, or fold, then companies start facing more financial pain, they start hiring less, then revenues drop. in a vicious loop.”
Ultimately, he said, it will be up to the Fed to nail down the economic teardown. Right now, he said, a recession is not imminent. But depending on what the Fed does — and how markets react — a recession could be a possibility within the next two years.
While a recession is a risk, it’s not a guarantee, Daco said. “There’s no guarantee we’ll end up in a recession because the Fed will be able to rethink, recalibrate monetary policy. But that’s a risk as we look to 2023.”
So an age-old advice remains true for individuals and families looking to bolster their finances before a recession: have an emergency savings account, use no more than about 30% of your available credit, pay down high-interest debt and be careful about spending on non-essential goods and services.