The odds of recession are rising, but the U.S. economy is not doomed to a downturn

High inflation and rising interest rates are dampening US growth, economists say, but there is still little chance of avoiding a second recession in three years.

The outlook is not good, that’s for sure.

The economy contracted in the first quarter for the first time since the start of the pandemic. The United States is also on track to grow by less than 1% in the spring based on the latest Wall Street estimates, putting it dangerously close to recession territory. A recession is generally considered two consecutive quarters of declining growth.

The most recent batch of economic signposts didn’t give much cause for optimism either.

The housing market has stalled due to soaring mortgage rates. Retail sales fell in May for the first time in five months. The number of people applying for unemployment benefits rose in June to a five-month high. And surveys of consumers and business leaders show serious concerns for the rest of the year.

All the bad news helped push up the Dow Jones Industrial Average DJIA,
+0.36%
below 30,000 for the first time in 17 months this week.

“A downturn has already begun,” said Bill Adams, chief economist at Comerica Bank in Dallas.

The Federal Reserve on Wednesday acknowledged the new challenges facing the economy, cutting its estimate for US growth this year to just 1.7% from 2.8%. Last year, the economy grew at a blistering 5.7%.

The Fed also lowered its assessment of the economy after approving the biggest interest rate hike in 28 years in an attempt to rein in runaway US inflation. The cost of living jumped 8.6% in the 12 months to May – the biggest increase in 40 years – and is likely to rise even more over the summer.

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The central bank is poised to raise a key US short-term interest rate to 3.4% by the end of the year. It had kept its benchmark rate close to zero during the pandemic, a cheap money strategy that helped the economy recover faster but also sowed the seeds of high inflation.

Rising interest rates are already throwing cold water on interest rate sensitive sectors of the economy, such as housing. The cost of a 30-year fixed mortgage has risen from 2.75% last fall to over 6% this month, freezing many buyers.

That’s not all. Higher rates will make it more expensive to buy a car, use credit cards, take out a business loan, or sell corporate bonds.

“There are definitely a lot of challenges ahead,” said Sam Bullard, senior economist at Wells Fargo in Charlotte. NC “The latest incoming data clearly indicates that there has been a loss of speed.”

Yet despite all the growing talk of recession, the US economy is still, in many ways, pretty solid.

“The underlying health of the economy looks better now than you would normally see when it is about to fall into recession.”


— Richard Moody, Regions Financier

Healthy vital signs

Unlike the 2007-2009 recession, for example, consumers and businesses are relatively low in debt and the US banking system is strong.

Most households were able to save a lot of money during the pandemic thanks to government stimulus payments and regular expenses they were able to forgo while working from home – clothes, gas, transportation, travel, entertainment, etc.

By some estimates, consumers have up to $2 trillion in “excess” savings compared to before the pandemic.

Consumers, the main drivers of the economy, also spend a lot of money. The only thing that has changed is that they spend relatively less on goods like cars or computers and more on services like restaurants, entertainment and travel.

Restaurant reservations tracked by OpenTable, for example, recently hit an all-time high. Demand for gasoline entering the summer driving season has surged despite record prices. Hotel reservations have exploded. And international travel is approaching pre-pandemic levels.

“There is still demand. People want to go out and do things. They have the funds to do it. Around [Charlotte, N.C.] you go to the restaurant and they are all full.


-Sam Bullard, Wells Fargo

“There is still demand. People want to go out and do things. They have the funds to do it,” Bullard said. “Around [Charlotte, N.C.] you go to the restaurant and they are all full.

What has helped Americans weather high inflation is the strongest job market in decades.

The United States has recovered almost all of the 20 million jobs lost during the pandemic and hiring is still quite robust. The economy added an average of 408,000 jobs per month in 2022.

“The underlying health of the economy looks better now than you would normally see when the economy is on the verge of falling into recession,” said chief economist Richard Moody of Regions Financial. “The economy has some ability to withstand higher rates and inflation. This ability is not infinite, but there is some leeway.

Although a handful of top companies recently announced layoffs, job postings remained near an all-time high.

“Other than crypto firms and a few tech companies, there’s hardly any talk of layoffs in the news,” said chief economist Stephen Stanley of Amherst Peirpont Securities.

Stanley, a frequent critic of the Fed who warned of high inflation last year, doesn’t think the economy and inflation will subside as quickly as the Fed would like.

The biggest labor shortage in decades might even be the saving grace of the economy.

Tens of millions of workers have taken advantage of the demand for labour, leaving one job for another and often receiving higher wages.

Average hourly wages for “non-supervisory” workers – anyone who isn’t a boss – have jumped 6.5% over the past year to partly assuage the pain of high inflation.

The difficulty in finding and retaining talent, moreover, could make companies more reluctant to carry out mass layoffs except as a last resort. It would be difficult to fill these positions once the economy improves.

“Think about how companies manage the workforce. Is it logical to think that they will lay off workers in large numbers? Moody said. He pointed out that the labor shortage appeared even before the pandemic and would likely persist for years.

What will ultimately decide the fate of the economy, analysts say, is how much the Fed will have to raise interest rates to stifle incendiary inflation — and how quickly price pressures s attenuate.

If inflation doesn’t slow sharply by the end of the year and the central bank has to raise rates to 4% or more, as some are predicting, that would likely be too much for an economy that has become addicted to rates. low interest rates over the past decade.

Inflation itself is also subject to the whims of forces beyond the control of the United States, such as the war in Ukraine. The conflict pushed oil and grain prices to stratospheric levels and inflamed already high inflation. Russia and Ukraine are major producers of food and energy.

Another huge source of inflation, continued supply shortages and global trade bottlenecks, is also largely beyond the Fed’s control. Higher rates could help by slowing demand and allowing suppliers to catch up.

“To avoid a recession, the economy will need some luck from energy prices and events outside of the United States,” said Adams of Comerica.

The US economy, however, has less and less room for error.

“The window to avoid a recession is narrower today, but a slowdown is not inevitable,” said chief US economist Oren Klachkin of Oxford Economics.

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