A Recession Is Coming—And Here’s How We Know
For many months, economic arrows have been pointing to a likely slowdown in economic growth in the U.S., possibly indicating a recession. A contracting economy appears likely with the latest U.S. GDP report showing economic growth slowed to a 1.1% annual rate in the first quarter, well below the previous quarter when the economy expanded by a steady 2.6% according to The Bureau of Economic Analysis. My economic analysis leads me to believe the U.S. economy will go into recession, possibly as soon as the third quarter of this year, but more likely slightly later.
Given that recessions are typically two or three quarters of economic contraction, I would expect the projected upcoming recession to persist into mid-2024 with lower levels of growth to follow. This is no cause for alarm, but it does signal that businesses and consumers alike are responding to the most visible culprit undermining the economy: persistent inflation.
Inflation has been cutting into purchasing power for consumers, with retail sales in March 2023 down 1.2% from February, according to government data. Consumer spending is the single biggest driver of the U.S. economy, and it continues to be impacted by higher prices, with real personal consumption expenditures showing no growth in March. If this continues, it makes a recession almost inevitable, despite some signs that inflation has been cooling down somewhat.
Expectations of a recession are causing business investment to fall, declining by over 8% in real terms over the past year. Business inventories are still rising, but at a declining rate compared to a year ago. Wages are still rising, putting upward pressure on production costs, although also at a slower rate versus last year.
For example, the Consumer Price Index (CPI) reading for March came in at 5% year-over-year, indicating inflation has fallen to a slower pace compared to 6% in February, as well as the 40-year high of more than 9% in June 2022. But inflation is still running hot overall, and well above the Federal Reserve’s long-term target of about 2%. In an attempt to control inflation, the Federal Reserve will have no choice but to continue its path toward higher interest rates. This week, the Fed raised interest rates by 0.25 percentage points—the same action it took in March. In a statement, the Federal Open Market Committee said it will “closely monitor incoming information and assess the implications for monetary policy” but, as Bloomberg reported, it did not repeat a line from its March statement about “some additional policy firming may be appropriate.” That is being interpreted by some observers as an indication that the Fed’s interest rate tightening may be over for now. The Fed may be more cautious about aggressively raising rates going forward with the economy slowing and potentially headed for recession.
MORE FOR YOU
Persistently high inflation, slowing spending, declining investment, interest rate increases—this is a textbook scenario for a recession, and one that is being closely watched by business leaders and global economists alike. In fact, business leaders, investors, and consumers would do well to track a broad array of indicators to gain a more complete picture of the U.S. economy and where it’s headed. Here’s a sampling:
- Layoffs announced by several large companies—among them 3M, Amazon AMZN , Meta (parent of Facebook), Goldman Sachs and others—tell a far different story than the labor market narrative of low unemployment. Job cuts and a slowdown in hiring indicate that the strength of the labor market is waning as a direct result of overall economic pessimism and concerns about recession.
- Over the past couple of years, nominal wages have been rising, roughly keeping pace with inflation. For example, in December 2022 median nominal wages grew by 6.1% while the CPI was up 6.4%. However, real wages growth (adjusted for inflation) is negative, which means U.S. household income overall has been hurt by inflation. As a result, household purchasing power has eroded, which points to recession.
- The class of 2023 is entering a more difficult job market. Data from the St. Louis Fed show an unemployment rate for college graduates of 5.4% in March 2023, up from 4.2% in December 2022. That reality could temper expectations among new graduates for first jobs and salaries.
- The U.S. housing market continues to slow, with existing home sales falling 2.4% in March 2023 from February levels and declining by 22% from a year ago. Higher mortgage rates have been largely to blame.
- Consumer sentiment has also turned downward, with indications that retail buyers are watching inflation and the economy overall with expectations of curbing their purchases. For example, a recent survey by CNBC and Momentive found that U.S. consumers could “buy less across more categories if inflation persists.” Tellingly, this attitude was found not only among lower-income consumers, but also those whose annual incomes are at least $100,000.
Economic data of the nontraditional variety add some texture. While anecdotal, they do point to a more cautious consumer who thinks twice when making a purchase.
- Discretionary spending has been under pressure as consumers need to pay up more for necessities such as food and gasoline. While discretionary purchases may be associated with luxury goods, the decline goes far deeper into that—for example, into home goods, according to Costco.
- McDonald’s CEO Christopher Kempczinski recently highlighted the importance of tracking the number of units or menu items per order. Or, as he was quoted in a Tweet, whether someone will “add fries to their order.”
- Apparently it’s a global phenomenon: according to Reuters, rising prices are hurting Britain’s economy—and higher costs of seafood and potatoes could put as many as one-third of UK fish-and-chip eateries out of business.
Admittedly, predicting economic turning points is difficult. However, much of the recent economic data is pointing in the direction of a recession. Many use the strength of the labor market as a counter argument; however, we are seeing slowing there, as well. .While employers are still hiring, the rate of growth in hiring is flat, while the number of job openings are still high, the number of openings is declining, falling 22% in March over last year, and new unemployment claims rose 11% in April over a year earlier.
While a recession is not inevitable, consumers and business leaders cannot ignore its possibility. Consumers need to cut back on spending, especially on credit, while business leaders should look to reduce hiring and other expenditures, in particular, capital expenditures.
Comments are closed.