Are We Heading Towards Another Recession?

In some ways, the economic picture in the U.S. is looking a little bit cloudy. But are we really headed for another recession?

A recession is a period of declining economic activity, generally defined as two consecutive quarters of negative gross domestic product (GDP) growth. GDP measures the total value of goods and services produced in an economy over a given period. Because large swaths of the overall economy depend on growth, a decline in GDP can create significant challenges for businesses, consumers, and governments worldwide. 

While it’s often easy to tell once a recession has started and completed in hindsight, it’s not always obvious beforehand or even in real-time. Pundits, citizens, and politicians might be quick to sound the alarm at the first sign of a pullback, but sometimes, their warnings are premature.

Factors and Indicators to Watch in Uncertain Times

Accurately predicting the arrival of an economic downturn could help businesses prepare. When America (or any country) starts to head for a recession, there can be multiple signs of trouble on the horizon.

But although many of the following factors may accompany a recession, they can be misleading at times. The overall economy depends heavily on the sentiment of consumers and business owners. When people feel that good times are coming to an end, they often react in ways that worsen the situation, bringing the pessimistic predictions to reality.

Yield Curve

The yield curve refers to the relationship between short-term and long-term interest rates on government bonds. It slopes upward when the economy grows but becomes flat or inverted during recessions.

A standard yield curve has short-term interest rates lower than long-term interest rates. Breaking this relationship signals an impending recession. The most recent inversion of the yield curve happened in late March 2022 for the first time since 2019 but has since been recorrecting.

When short-term interest rates are lower than long-term interest rates, investors are willing to accept less interest income for shorter periods. But when investors expect an economic slowdown, they demand higher interest rates for shorter-term bonds than for longer-term bonds because of the expectation that rates will decline in the future.

Inflation

Inflation is another critical metric for monitoring the health of the economy. It’s driven by increases in the money supply and measured as the sum of all currency held outside banks and the money they’ve lent to customers. 

Easy credit and massive Covid stimulus packages have driven inflation beyond 8% in early 2022. While this should be the peak, some analysts and the IMF expect it to stay above 6% for some time.

High inflation can lead to consumers spending less on goods and services because their dollars don’t go as far, and they feel poorer. Quickly rising prices make it harder for businesses and consumers alike to afford rent, transportation, and food. This spending slowdown hampers economic growth and prolongs recessions.

Interest Rates

Interest rates are more than a lever used by the Federal Reserve to control the economy. A rise in interest rates makes loans more expensive, causing companies to borrow less money, which leads to lower investment in equipment or hiring. Increasing rates make paying off debt balances on variable interest rate loans more expensive.

Interest rates aren’t only about money; they also affect the stock market. Stocks are often used as a barometer for the broader economic sentiment and tend to go down when interest rates go up.

To stimulate the flow of money, the Federal Reserve will often cut interest rates when it expects slow economic growth. Conversely, when the economy is growing quickly and the Fed sees inflation risk, it may raise interest rates. To keep inflation in check, the Fed has started to increase rates in 2022, with 50 basis-point hikes expected in June and July.

Labor Market and Unemployment

The labor market and the overall economy are closely linked. Labor is often measured by the unemployment rate, the percentage of people who don’t have a job but are actively looking for work. 

High unemployment indicates that businesses aren’t hiring as they would in more robust economic times. The natural unemployment rate is the lowest that unemployment can go without causing inflation. 

A rapid rise in unemployment above its natural state often signals a slowdown in the economy. Although employment is rarely the cause of a recession, rising unemployment reinforces the slowing economy and prolongs the downturn. However, the current 3.6% unemployment rate indicates many available jobs and a strong demand for hiring.

GDP Growth

Because most recession definitions refer to a declining gross domestic product, the two are inarguably interlinked. High GDP growth signals that the economy is growing, and there’s a good chance businesses will be hiring. On the other hand, low GDP growth might lead to reduced hiring and investment in new projects.

Closely monitoring GDP growth can indicate the health of an economy. Although U.S. GDP declined by 1.5% in the first quarter of 2022, Q4 2021 growth was quite strong at 6.9%. But as with the labor market, it’s hard to say whether the lack of GDP growth is the cause or the result of reduced hiring and poor economic outlooks.

Outlook and Uncertainty

The U.S. economy is still expected to grow in 2022 but at a notably slower pace than was previously projected. This is largely due to a global economic pullback driven by reverberations from Covid and several other critical factors.

Uncertainty in Ukraine and the Middle East has caused oil prices to spike above $100 per barrel again. Limited oil and gas supplies cause prices to go up when there is a disruption, and energy costs are a significant part of the overall economy. Changes in prices can cut into profits or cause businesses and consumers to cut back elsewhere.

Many products are made in or passed through Chinese ports or factories. Covid lockdowns there have also caused supply chain disruptions that affect countries importing from China. As a result, many manufacturers may need to lay off workers or close their operations. The production of fewer goods hinders economic growth.

Finally, rising mortgage rates and increased prices have started to slow the American housing market, as pending home sales have declined for six consecutive months. However, despite this slump, home sales have been stronger in more affordable regions of the country, such as the South and the Midwest.

What Kind of Recession Might We Be Heading Towards?

The last major recession, the Great Recession, resulted in a 4.3% decline in GDP and was one of the largest and deepest recessions in modern history. Before the brief Covid-19 recession in early 2020, the U.S. economy had seen steady growth since the Great Recession ended in 2009.

Fortunately, the Covid recession technically lasted only two months, much shorter than the average length of around 11 months. Government stimulus and a quick shift to home-based work kept people employed and quickly helped jumpstart the economy.

It’s hard to say what kind of recession the next one could be, but the chances are high that it could be a typical business-cycle recession, where unemployment rises and GDP falls

Opinion is Divided

Although no one can predict the future, there are signs that the U.S. economy might be heading for a recession. On top of the current global uncertainty and supply chain disruptions, many familiar precursors signal cause for concern: an inverted yield curve, rising interest rates, and high inflation.

However, opinions differ on whether we’re in for another downturn. 

Unemployment is at record lows—around 4%—and the White House is confident of solid GDP growth in 2022 despite inflation risks. The IMF says a recession is coming—but not until 2023 or 2024. For 2022, they share the White House’s optimism and are projecting 3.7% GDP growth. 

Fortunately, if there is a recession, corporate profits are currently strong, and households have trillions in savings and relatively low debt loads. These factors, along with proactive business strategies, will provide some cushion for business owners if we do see an economic pullback.