With market turmoil, high inflation and impending interest rate hikes making borrowing more expensive, many Americans are wondering if the economy is heading for recession.
Goldman Sachs president Lloyd Blankfein said last weekend that “it is definitely a very, very high risk factor” and consumers should be “ready for it”. However, he compensated by saying that the Federal Reserve “has very powerful tools” and that the recession “does not bake the cake”.
Although it is impossible to know for sure, the chances of a US recession next year are steadily increasing, according to a recent Bloomberg survey of 37 economists. They have a 30% chance of being tied up, which is twice the chance three months ago.
To put this number in context, the threat of a recession is usually around 15% in a given year, due to unexpected events and many variables.
The bottom line: “The chances of a recession this year are quite low,” said Gus Faucher, chief economist at PNC Financial Services Group. However, “it becomes more difficult in 2023 and 2024.”
What determines if the economy is entering a recession
The recession is a significant reduction in economic activity that spreads across the economy and lasts for more than a few months, according to the National Bureau of Economic Research, which is officially declaring a recession.
A key indicator of a possible recession is real gross domestic product (GDP), an inflation-adjusted value of goods and services produced in the United States. For the first time since the beginning of the pandemic, it fell at an annual rate of 1.4% in the first quarter of 2022. As many economists agree that 2% is a healthy annual GDP growth rate, a negative quarter for the beginning of the year suggests that the economy may be shrinking.
Another factor is rising inflation, which has recently shown signs of slowing. However, it is still well above the Fed target of 2%, with an annual interest rate of 8.3% in April, according to the latest figures from the Consumer Price Index.
With high inflation, higher prices outweigh wage increases, making things like gas and rent more expensive for consumers. That’s why the Fed is raising interest rates, as it did in March and May, with five more expected to follow this year. These increases discourage spending by making the cost of borrowing money more expensive for businesses and consumers.
While many economists still expect GDP to grow in 2022, the rate at which inflation is declining is less clear.
Signs of financial strength
However, there are also positive economic indicators that need to be taken into account. Job numbers continue to look good, as the US economy in April had its 12th consecutive month with earnings of 400,000 or more jobs. Both employment levels and consumer spending remain strong for the time being, despite rising interest rates and inflation.
“Ultimately, inflation in terms of price increases must move to the real behavior of spending,” said Victor Canalog, head of commercial real estate at Moody’s.
He points out that consumer spending in the US has increased by 2.7% in the last quarter: “People are still spending more, but at what point will they start spending less?”
Despite these positives, the risks remain. The US Federal Reserve is on a fine line with its monetary policy, Faucher says, as doing too little or too little to control inflation could hurt the economy further.
“The rate hike is designed to slow growth, we hope it does not push the economy into recession,” Faucher said. But he says if the central bank “raises interest rates too much, it could push the economy into recession.”
“That is why I am more worried about 2023 or 2024, because we will have felt the cumulative impact of all these interest rate hikes that we are going to see in the next year and a half.”
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