Is A Recession Coming? – Forbes Advisor

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The Covid recession of early 2020 was the shortest US recession on record. The question now is how long the post-Covid economic rebound can last—and whether we might even be heading for another recession.

The Federal Reserve recently raised interest rates for the first time since 2018—to a range of 0.25% to 0.50%—and suggested that the federal funds rate could climb to 2.5% or higher by the end of 2022. In forecasts released with the rate decision, Fed economists lowered their economic growth projections for the year.

The initial look at first quarter US gross domestic product (GDP) was -1.4%, increasing fears that a recession could be a nearer proposition than many had thought. Meanwhile, high inflation is dampening consumers’ moods, while the Russian invasion of Ukraine has pushed oil prices higher worldwide.

“The Fed has a narrower path to be able to address inflation and not kick us into a recession,” says Mace McCain, chief investment officer at Frost Investment Advisors. “If the Fed were to follow through on these forecasted rates, we think the risk of a recession would be much higher than the market currently expects and could represent significant downside risks.”

Just don’t lose yourself in the bad news quite yet.

The US labor market remains very healthy—two reasons why the Fed feels comfortable raising rates in the first place. Economic growth is going to decelerate, but that’s how you fight inflation.

While keeping an eye on potential economic pitfalls ahead is a good exercise for any investor, there’s a scant benefit in believing they are inevitable. As the Nobel-prize winning economist Paul Samuelson once famously joked, economists have accurately predicted nine out of the past five elections.

Why Are Analysts Worried about Another Recession?

Perhaps the biggest concern of experts who see a potential recession coming are the big changes in the Federal Reserve’s strategy. After playing down inflation for much of 2021, the Fed has finally found religion when it comes to getting price growth under control.

The Fed started preparing markets for tighter monetary policy in January, when Fed Chair Jerome Powell said the central bank would lower its $9 trillion balance sheet sometime in 2022 and begin the process of withdrawing cheap money from the economy. This put pressure on stocks across the board—especially high-flying tech companies that thrive in such an environment.

Powell rolled out the next step by not only raising the federal rate funds, but also signaling that there could be as many as seven rate hikes this year. Goldman Sachs expects the Fed to be even more aggressive in upcoming meetings, raising rates by 50 basis points instead of just 25 basis points.

At a conference in March, Powell said that the central bank must move “expeditiously” to raise rates fast enough so that inflation expectations don’t rise further. Inflation assumptions are nothing more than the idea that people come to believe there will be higher prices in the future, and they have a slew of consequences—like accelerating wages—which can make it even harder to get inflation back toward the Fed’s 2% target .

At first glance, the Fed’s strategy seems pretty reasonable. The consumer price index (CPI) is at 40-year highs. But some worry that after downplaying the pace of inflation in 2021—remember “transitory”—the central bank will be too trenchant as it increases borrowing costs.

“Should the Fed overtighten,” said Jason England, global bonds portfolio manager at Janus Henderson Investors, “the US economy could slip into recession.”

Given the high rate of inflation, especially in oil and food, it’s not hard to picture consumers dialing back their spending to compensate. While taking some spending out of the economy is why the Fed is raising rates, economic growth could stall consumers clam up too much.

GDP and Recessions

The definition of what constitutes a US recession is somewhat flexible, but two successive quarters of negative economic growth is the standard definition.

The Great Recession, for instance, lasted from December 2007 until June 2009 and resulted in a 4.3% decline in gross domestic product (GDP). It was one of the largest and deepest recessions in modern history.

The Covid-19 Recession was different—it only lasted two months, much shorter than the standard measure. Why was this period called a recession? Because the National Bureau of Economic Research (NBER), an independent, non-profit economic research firm that officially calls recessions in the US, defines one as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months,” per the NBER’s website.

The NBER believed that the economic decline that accompanied the first months of the pandemic was so deep that it warranted being called a recession, despite its brevity.

And while few economists are predicting negative GDP growth right now, analysts are lowering their growth forecasts.

Goldman Sachs recently cut its outlook for 2022 US GDP from +2% to +1.75%, thanks to higher oil prices as a result of Russia’s war in Ukraine. This forecast dovetails with the Atlanta Federal Reserve Bank’s GDPNow outlook. As we noted above, the Fed lowered its expectations for 2022 GDP growth from +4% to +2.8%.

Watch the Yield Curve

Another commonly watched market indicator is making analysts very nervous: the yield curve. This metric compares what investors can earn on short-term Treasury securities versus longer-term Treasury securities.

In a healthy economy, investors demand higher yields on longer-term debt to compensate them for taking on longer-term risks. When the difference between these two yields shrinks—as investors demand higher yields on shorter-term debt—it may signal concern that tough times are around the corner.

The yield curve has seen this exact scenario recently, suggesting that investors expect economic growth to slow in the future. Yields on shorter-term and longer-term Treasury securities have been converging, drawing comments from some quarters that the market may be signaling a recession.

The Case Against a Looming Recession

There are plenty of experts that acknowledge these risks but believe they’re probably overblown.

“Right now, the central bank has a lot on its plate. It needs to balance the inflation narrative alongside the risk of sending the US economy into a recession,” says Giles Coghlan, chief analyst at HYCM. “Going forward, any further hiking action will come with caveats—we may see a more dovish approach to tightening, rather than the aggressive approach we have been primed for over the past year.”

There is a risk that the Fed could raise interest rates too far too fast, but there’s nothing stopping the central bank from adopting a more temperate approach as more economic data emerges.

After all, supply chain problems will eventually work themselves out, easing pressure on goods prices. And while the labor market is tight, there are still millions of fewer workers now than before the pandemic. More workers means less competition for labor, which would result in a limit on wage inflation.

It’s not as if pay is out of control now. After you adjust for inflation, wages declined 2.3% in February compared to the year period, according to the Bureau of Labor Statistics.

And while it’s true that the yields on 10-year and 2-year Treasuries are getting close—that yield curve warning mentioned above—there’s still a sizable gap between 10-year and 3-month Treasuries.

“The 10-year/2-year gap is but one part of the yield curve. Another important part of the curve, the 10-year/3-month, has steepened,” said Tim Holland, chief investment officer at Orion Advisor Solutions. “If the past 30 years is any guide, both parts of the curve need to flatten and invert before we are at risk of recession.”

That’s the gauge that the New York Fed uses to make its predictions for a recession. Currently the Reserve Bank puts a 6% chance on a recession happening soon, compared to almost 40% last August.

Should You Be Worried About a Recession?

This hasn’t been the most enjoyable economic expansion in history. While the S&P 500 has almost doubled from its post-pandemic lows, the current bull market has been defined by high volatility and low consumer confidence.

Thanks to high inflation and supply chain issues, Americans aren’t feeling optimism about their finances. The most recent Forbes Advisor-Ipsos survey found that people haven’t moved on from the Covid-19 malaise that’s defined the past two years.

Meanwhile, housing sales are declining as financing costs rise, and there are a dearth of homes on the market. Should the trend continue and worsen, that might augur a recession.

“In my view of the probability of a recession within the next year is not particularly elevated,” Powell said at the March FOMC meeting. He cited strong spending, a strong labor market and healthy household finances.

The hardest thing to do is to keep perspective. But that’s generally the best medicine.

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