Recession fears are growing. How high is the risk?

Inflation is at its highest for 40 years. Stock prices are collapsing. The Federal Reserve makes borrowing much more expensive. And the economy actually contracted in the first three months of this year.

Is the United States at risk of another recession, just two years after emerging from the previous one?

For now, most economists do not expect a slowdown in the near future. Despite the compression of inflation, consumers, the main driver of the economy, continue to spend at a good pace. Companies are investing in hardware and software, reflecting a positive outlook. And the labor market is still booming, with strong hiring, few layoffs, and many employers eager to recruit more workers.

“Nothing in the US data currently suggests a recession is imminent,” Rubeela Farooqi, chief US economist at High Frequency Economics, wrote on Tuesday. “Job growth remains strong and households continue to spend.

That said, Farooqi warned, “the economy faces headwinds.”

Among the signs that recession risks are growing: High inflation has proven to be far more entrenched and persistent than many economists – and the Fed – 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 due to COVID-19 have worsened supply shortages.

Fed Chairman Jerome Powell pledged to do everything in his power to curb inflation, including raising interest rates to such a level that it would weaken the economy. If that happens, the Fed could potentially trigger a recession, possibly in the second half of next year, economists say.

Wednesday, the The Fed is about to raise its key rate, which affects many personal and business loans, by up to three-quarters of a percentage point. It would be the Fed’s biggest rate hike since 1994, and it could herald the start of a period of particularly aggressive central bank credit tightening — and with it, a higher risk of a recession.

Analysts say the U.S. economy, which has thrived for years on ultra-low borrowing costs, may not be able to withstand the impact of much higher rates.

The country’s unemployment rate is at a nearly half-century low of 3.6%, and employers are posting a near-record number of job vacancies. Yet even an economy with a healthy labor market can eventually suffer a recession if borrowing becomes more expensive and consumers and businesses rein in spending.

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HOW WILL FED RATE HIKES WEAKEN THE ECONOMY?

Higher lending rates will certainly slow spending in areas that force consumers to borrow, housing being the most visible example. The average 30-year fixed-rate mortgage rate topped 5% in April for the first time in a decade and has stayed there ever since. A year ago, the average was less than 3%.

Home sales fell accordingly. The same is true for mortgage applications, a sign that sales will continue to slow. A similar trend could occur in other markets, for cars, household appliances and furniture, for example.

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HOW ARE EXPENSES AFFECTED?

Corporate borrowing costs are rising, as evidenced by higher corporate bond yields. At some point, these higher rates could weaken business investment. If companies forgo buying new equipment or expanding capacity, they will also start to slow down hiring. Growing corporate and consumer caution about free spending could further slow hiring and even lead to layoffs. If the economy were to lose jobs and the public grew increasingly fearful, consumers would cut spending further.

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IS A STOCK MARKET IN SNOW HARMFUL TO THE ECONOMY?

Falling stock prices may discourage affluent households, who collectively own the bulk of America’s stock market wealth, from spending as much on vacation trips, home renovations or new appliances. Broad stock indices have been falling for weeks. Falling stock prices also tend to reduce the ability of companies to grow. Wage growth, adjusted for inflation, would slow and leave Americans with even less purchasing power. Although a weaker economy would eventually reduce inflation, until then, high prices could hamper consumer spending. Eventually, the downturn would feed on itself, with layoffs mounting as economic growth slowed, leading consumers to increasingly cut back on spending, fearing they too could lose their jobs.

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WHAT ARE THE SIGNS OF AN IMPENDING RECESSION?

According to economists, the clearest signal that a recession could be approaching would be a steady increase in job losses and rising unemployment. Typically, an increase in the unemployment rate of three-tenths of a percentage point, on average over the previous three months, means that a recession will eventually follow.

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OTHER SIGNALS TO WATCH?

Many economists also watch changes in interest payments, or yields, on different bonds for a signal of recession known as an “inverted yield curve.” This happens when the yield on the 10-year Treasury falls below the yield on a short-term Treasury. , such as 3-month Treasury bills. This is unusual, as longer-term bonds generally offer investors a higher return in exchange for locking up their money for a longer period.

Inverted yield curves usually mean investors are anticipating a recession and will force the Fed to cut rates. Inverted curves often predate recessions. Yet, it can take up to 18 or 24 months for the downturn to occur after the yield curve inverts. A short-lived reversal occurred on Tuesday, when the two-year Treasury yield briefly fell below the 10-year yield, as it did temporarily in April. Many analysts say, however, that comparing the 3-month yield to the 10-year yield has a better record when it comes to predicting recession. These rates are not reversing now.

Powell said the Fed’s goal was to raise rates to cool borrowing and spending so companies reduce their huge number of job openings. In turn, Powell hopes, companies won’t have to raise wages as much, easing inflationary pressures, but without major job losses or an outright recession.

“I expect it to be very difficult,” Powell said. “It’s not going to be easy.”

Although economists say it’s possible the Fed will succeed, most also say they are skeptical of the central bank’s ability to rein in such high inflation without ultimately derailing the economy.

Deutsche Bank economists believe the Fed will need to raise its key rate to at least 3.6% by mid-2023, enough to cause a recession by the end of this year.

Still, many economists say any recession would likely be mild. American families are in much better financial shape than before the protracted Great Recession of 2008-2009, when falling house prices and the loss of jobs ruined the finances of many households.

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