With market turmoil, high inflation and impending interest rate hikes that will make borrowing more expensive, many Americans are wondering if the economy is headed for a recession.
Goldman Sachs chairman Lloyd Blankfein said last weekend that “it’s definitely a very, very high risk factor” and that consumers should “be prepared for it.” However, he covered his comments by saying that the Federal Reserve “has some very powerful tools” and that a recession is “not baked in the cake.”
While it’s impossible to know for sure, the odds of a US recession next year are steadily increasing, according to a recent Bloomberg survey of 37 economists. They have a probability set at 30%, which is double the chance of three months ago.
To put that number into context, the threat of a recession is typically around 15% in any given year, due to unexpected events and many variables.
In summary: “The likelihood of a recession this year is quite low,” says Gus Faucher, chief economist at financial services firm PNC Financial Services Group. However, “it becomes more difficult in 2023 and 2024”.
What determines if the economy goes into a recession
A recession is a significant decline in economic activity that spans the entire economy and lasts longer than a few months, according to the National Bureau of Economic Research, which officially declares recessions.
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 start of the pandemic, it declined at an annual rate of 1.4% in the first quarter of 2022. Given that many economists agree that 2% is a healthy annual growth rate for GDP, a negative quarter to start the year suggests the economy may be contracting.
Another factor is rising inflation, which has recently shown signs of slowing down. But it remains well above the Fed’s 2% benchmark target, with a year-over-year rate of 8.3% in April, according to the latest price index figures at the consumption.
With high inflation, higher prices outpace wage growth, making gasoline and rent more expensive for consumers. For this reason, the Fed is imposing interest rate hikes, as it did in March and May, and five more are expected to follow this year. These increases discourage spending by making the cost of borrowing more expensive for businesses and consumers.
While many economists still expect GDP to grow in 2022, the pace at which inflation is falling is less clear.
Signs of economic strength
However, there are also positive economic indicators to consider. Employment numbers continue to look good as the US economy in April saw its 12th consecutive month of job gains of 400,000 or more. And employment levels and consumer spending remain solid, for now, despite interest hikes and inflation.
“Ultimately, inflation in terms of rising prices has to trickle down to actual consumer behavior,” says Victor Canalog, head of commercial real estate economics at Moody’s.
He points out that consumer spending in the United States increased by 2.7% in the last quarter: “People are always spending more, but when will they start spending less?
Despite these positive aspects, risks remain. The Federal Reserve is walking a fine line with its monetary policy, Faucher says, because doing too much or too little to control inflation could further hurt the economy.
“Rising interest rates are designed to cool growth, hopefully without plunging the economy into recession,” Faucher said. But he says if the central bank “raises rates too much, it can push the economy into recession.”
“That’s why I’m more concerned about 2023 or 2024, because we will have felt the cumulative impact of all these interest rate increases that we’re going to see over the next year and a half.”
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