Why a recession is likely

Yikes.

You’ve probably seen headlines that the US is headed for a recession. There are a number of factors to indicate that might happen down the line, in about 18 months. Let’s take a look at a few of those factors and see what might determine if that’s true.

First, if you’re wondering what exactly a recession is, it’s when the economy contracts for two consecutive quarters (three months). It’s not as bad as a depression (which is when an economy goes into contraction for five or more years) but it’s still something most economists try to avoid whenever possible. That definition became popular in 1974 by economist Julius Shiskin.

The National Bureau of Economic Research (NBER) NBER has its own definition of what makes up a recession, namely “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

There are a number of ways a recession can be triggered - economic shocks, excessive debts, asset bubbles, too much inflation/deflation, and technological change. Let’s take a look at which factor might trigger the next one.

Federal Reserve

The Fed (what many people call the Federal Reserve) is not really part of the federal government at all. It isn’t owned by anyone, and no single person controls it. It’s technically an independent central bank, but its actions are directed by Congress and ultimately approved by both houses. The Fed implements monetary policy to keep inflation low and unemployment high while maintaining moderate long-term interest rates.

Inflation is running high - from gas prices to groceries. The Fed’s goal is to keep inflation at 2% and it’s currently at about 5%. The figure reported Thursday by the Commerce Department, was the largest year-over-year rise since January 1982. To offset a recession caused by increased inflation, the Fed increased it’s short-term interest rates, which means borrowing is more expensive and could weaken the economy over time. That’s because these interest rates affect consumer and business loans.

The Fed’s target objective for inflation is 2%. Right now, it’s higher due to a number of factors. Because it’s so high, the Fed will increase interest rates, which could hurt the American economy.

The Yield Curve

An indicator of a recession is the “yield curve”. If you want to know the specifics of a yield curve, read more here.

**Basically, the yield curve plots the yield of all Treasury securities, which includes bonds. The yield slopes upward because investors will take a risk at buying bonds. That’s because they expect to be compensated in the long run, so the cost is worth it. The yield curve inverted Tuesday for two-year bonds, meaning investors don’t have a strong outlook on the strength of the U.S. economy. They don’t have a strong outlook because they know the Fed will step in, increasing interest rates and making borrowing more expensive for consumers (think mortgages, car loans, etc).

**Read comment thread for a point on the yield curve from a subscriber (3/31)

Counterpoint: The yield curve is a powerful indicator of a recession, but it hasn’t always been right. There have been 28 instances since 1900 where the 2/10 (going to expand on what 2/10 means in the next paragraph) yield curve has inverted; in 22 of these episodes, a recession has followed, according to Anu Gaggar, Global Investment Strategist for Commonwealth Financial Network.

Also, this is just for the 2/10 yield curve. I’m not going to get too technical in this regard, but basically the 2/10 refers to two-year yield curves, when there are also five- year, 10-year, and 30-year yield curves which can explain investor sentiment in the long-term and how they feel about the strength of the U.S. economy.

In a report by the Financial Times, one expert says that the current two-year yield may be distorted because of COVID. The report explains,

”The Fed, as part of its intervention in financial markets during the market collapse in March 2020, began buying huge swaths of US government debt to shore up the economy. The central bank this month ended that $120bn-a-month bond-buying programme and as it has pulled back, the flood of Treasuries to the market has driven prices lower and yields higher.”

Yikes

I believe a recession is likely - the Fed is raising interest rates, investors don’t feel confident about the immediate growth of the U.S. economy, and consumer confidence is at a low. I’m not sure how long it will last, but I believe it might come in 2023 based off of previous yield conversions and previous expert opinions, who have been predicting this since the end of 2021.

The next few months will help us predict how long the recession will occur. Some experts don’t believe it will take too long, citing industrial production, American savings, and consumer demand.

From a first-person perspective - I know I’ll do a lot more spending due to moving apartments, but other than that, I’ll be saving. An increase in grocery and gas prices plus student loan payments starting in May don’t have me confident about consumer sentiment for spending, but I do have more confidence further down the line.