What is recession risk as economy struggles?
WASHINGTON — Inflation is at a 40-year high. Stock prices are sinking. The Federal Reserve is making borrowing much costlier. And the economy actually shrank in the first three months of this year.
Is the United States at risk of enduring another recession, just two years after emerging from the last one?
For now, most economists don’t foresee a downturn in the near future. Despite the inflation squeeze, consumers — the primary driver of the economy — are still spending at a healthy pace. Businesses are investing in equipment and software, reflecting a positive outlook. And the job market is still booming, with hiring strong, layoffs low and many employers eager for more workers.
“Nothing in the U.S. data is currently suggesting a recession is imminent,” Rubeela Farooqi, chief U.S. economist at High Frequency Economics, wrote Tuesday. “Job growth remains strong and households are still spending.
That said, Farooqi cautioned, “the economy faces headwinds.”
Among the signs that recession risks are rising: High inflation has proved far more entrenched and persistent than many economists — and the Fed — had expected: Consumer prices rose 8.6% last month from a year earlier, the biggest annual 12-month jump since 1981. Russia’s invasion of Ukraine has exacerbated global food and energy prices. Extreme lockdowns in China over COVID-19 worsened supply shortages.
Fed Chair Jerome Powell has vowed to do whatever it might take to curb inflation, including raising interest rates so high as to weaken the economy. If that happens, the Fed could potentially trigger a recession, perhaps in the second half of next year, economists say.
On Wednesday, the Fed is set to raise its benchmark interest rate, which affects many consumer and business loans, by as much as three quarters of a percentage point. That would be the Fed’s largest rate hike since 1994, and it could herald the start of a period of especially aggressive credit tightening by the central bank — and with it, a higher risk of recession.
Analysts say the U.S. economy, which has thrived for years on the fuel of ultra-low borrowing costs, might not be able to withstand the impact of much higher rates.
HOW WOULD THE FED’S RATE HIKES WEAKEN THE ECONOMY?:
Higher loan rates are sure to slow spending in areas that require consumers to borrow, with housing the most visible example. The average rate on 30-year fixed mortgages topped 5% in April for the first time in a decade and has stayed there since. A year ago, the average was below 3%.
Home sales have fallen in response. And so have mortgage applications, a sign that sales will keep slowing. A similar trend could occur in other markets, for cars, appliances and furniture, for example.
HOW IS SPENDING AFFECTED?:
Borrowing costs for businesses are rising, as reflected in increased yields on corporate bonds. At some point, those higher rates could weaken business investment. If companies pull back on buying new equipment or expanding capacity, they will also start to slow hiring. Rising caution among companies and consumers about spending freely could further slow hiring or even lead to layoffs. If the economy were to lose jobs and the public were to grow more fearful, consumers would pull back further on spending.
DOES A SINKING STOCK MARKET HURT THE ECONOMY?:
Falling stock prices may discourage affluent households, who collectively hold the bulk of America’s stock wealth, from spending as much on travel, home renovations or new appliances. Broad stock indexes have tumbled for weeks. Falling share prices also tend to diminish the ability of corporations to expand. Wage growth, adjusted for inflation, would slow and leave Americans with even less purchasing power. Though a weaker economy would eventually reduce inflation, until then high prices could hinder consumer spending. Eventually, the slowdown would feed on itself, with layoffs mounting as economic growth slowed, leading consumers to increasingly cut back out of concern that they, too, might lose their jobs.