What are the warning signs of a recession?
The early 2020s were a tough time for the U.S. economy. They began with the COVID-19 pandemic, which snarled global supply chains and triggered a short but painful recession. Then, as the economy reopened, increased spending sent inflation to levels not seen in decades.
The Federal Reserve responded with a plan to raise interest rates and bring inflation back under control. But rather than reassuring investors, that announcement gave them a new source of anxiety. It led them to worry that the Fed’s actions would drive the U.S. into another recession. Between March and May 2022, Google searches for “recession” roughly quintupled.
However, economists aren’t of one mind about whether the U.S. should expect a recession in 2022. They generally agree on what’s going on with the U.S. economy right now, but they disagree on what it means for the future.
Is a Recession Coming? Warning Signs of Economic Slowdown
Even experts can’t predict the timing of a recession very accurately. However, they can point to general trends that indicate a downturn might be on the way. The more warning signs are present, the greater the likelihood of a recession.
1. High Inflation
Inflation, in itself, is not a sign of a recession. In fact, inflation tends to be highest during periods of high economic growth. However, recessions often follow on the heels of high inflation because of the way the government responds to it.
When inflation is high, central banks like the Federal Reserve raise interest rates. This encourages consumers to spend less, driving prices down. But it’s very easy for a central bank to overshoot and reduce spending too much, pushing the economy into a recession.
The U.S. experienced unusually high inflation in 2021 and 2022. In March of 2022, the inflation rate hit 8.5%, its highest level in over 40 years. The Fed responded by announcing plans for a series of interest rate hikes in 2022. Many experts fear this will push the U.S. into a recession.
Of 30 economists surveyed by CNBC in May 2022, 57% thought the Fed’s rate hikes would lead to a downturn. However, they didn’t generally think the recession would arrive in 2022. Their average predicted start date was August 2023.
2. Global Economic Instability
Today, we live in a global economy. That means problems in other parts of the world can create problems for the U.S. economy as well. War, famine, and natural disasters can all affect global supply chains, affecting the prices of goods in the U.S.
In 2022, there are many such problems affecting the economy. The COVID pandemic has caused supply-chain disruptions that contributed to our high inflation. These disruptions have become more severe due to the recent lockdowns imposed in China, a major U.S. trade partner.
Russia’s invasion of Ukraine made matters worse by reducing exports from both countries. The sanctions the U.S. and other nations imposed on Russia have driven up oil prices worldwide, resulting in higher gas prices for U.S. consumers. And food prices have also risen because both Russia and Ukraine are major grain exporters.
Meanwhile, climate change lurks as an ever-present threat in the background. Droughts, hurricanes, and wildfires are all likely to be more severe because of it. That increases the chances of a major disaster that would disrupt production and infrastructure in the U.S. or elsewhere.
All these factors make inflation harder to control. That increases the risk that the Fed will impose the kind of steep interest rate hikes that could trigger a recession. In an April 2022 survey by Allianz Life, a majority of Americans said they fear world tensions will lead to a U.S. recession.
3. A Negative Yield Curve
The Treasury bond yield curve is a plot of the yields (interest rates) on short-term and long-term Treasury securities. Typically, the longest-term bonds have the highest yields. But occasionally the yield curve flips, or inverts, with short-term bonds paying higher interest rates.
When this happens, it’s a sign Americans are worried about the economy. They’re rushing toward low-risk investments, such as long-term Treasury bonds, because they don’t trust the stock market.
There’s one specific yield curve inversion that signals a recession very accurately. If the interest rate for 10-year Treasuries falls below the yield for three-month Treasuries and stays that way for three months, that almost always means a recession is coming.
In early 2022, some parts of the yield curve briefly inverted. According to the U.S. Treasury, in March and April the yield for 3-year bonds rose above the yield for 10-year bonds for a couple of weeks. Even the 2-year bond yield was over the 10-year bond yield for a couple of days.
However, these inversions didn’t last long and didn’t extend to the crucial difference between the three-month and 10-year securities. So while they may be a mild cause for concern, they’re not yet a conclusive sign that a recession is on its way.
4. Low Consumer Confidence
The U.S. economy relies on consumer spending. There’s no point in producing goods and services if no one wants to buy them. That’s why consumer confidence is an important economic indicator.
When consumers don’t feel secure about the economy, they’re less willing to spend. They save up their money for the rainy day they suspect is coming. Unfortunately, these fears can become a self-fulfilling prophecy, as lower consumer spending drives the economy into a recession.
Surveys of consumer confidence in 2022 are mixed. The University of Michigan’s Survey of Consumer Sentiment fell sharply from December 2021 through May 2022. But the Conference Board’s Consumer Confidence Index finds people still feel mostly positive about the economy.
If Americans are worried, it hasn’t affected their spending too much yet. A May 2022 McKinsey survey found that U.S. consumers had spent 18% more in March 2022 than they did two years earlier, before the pandemic took hold.
However, there are some early signs that spending may be falling off. In May 2022, CNBC reported that sales had fallen off at Walmart, which caters to low-income consumers. Shoppers were buying fewer items, and more of them were switching to the store brand to save money.
5. Low Business Confidence
Consumer spending is only part of the U.S. economy. Spending by businesses is also important. Business owners are less likely to hire workers or invest in production when they’re concerned about the future.
And in 2022, they are concerned. The CNBC Small Business Survey from April found that small business confidence was near an all-time low. The vast majority of small business owners rated the economy as either fair or poor.
Inflation was their top concern, but they also worried about supply chain disruptions, labor shortages, and the ongoing pandemic. Over 80% of them thought a recession in 2022 was either very likely or somewhat likely.
Larger businesses are also concerned, but not as much. Moody’s Business Confidence Indicator for the U.S. shows a modest drop in confidence from October 2021 through April 2022. However, it still remains above the historical average.
6. Weak Stock Market
In May 2022, U.S. stocks briefly entered a bear market. The official definition of a bear market is a 20% drop in stock prices from their latest high point. When this happens, it’s a sign that investors are feeling pessimistic about the economy.
By itself, a drop in the stock market isn’t a reliable indicator of a recession. Stock prices go up and down all the time, often for reasons that have little to do with the broader economy.
In this case, though, investor uncertainty is definitely a factor behind the drop in stock prices. It reflects fears about inflation, the global situation, and the possibility of a coming recession.
7. Declining Real GDP
According to the National Bureau of Economic Research, the official definition of a recession is “a significant decline in economic activity spread across the economy, lasting more than a few months.” The main measure of economic activity is the gross domestic product, or GDP. It’s the value of all the goods and services the economy produces. So, by definition, a recession always means a drop in GDP.
U.S. GDP has indeed fallen in 2022, but only slightly. In the first quarter, the annual GDP growth rate was −1.4%. This could signal the start of a recession, but it’s too soon to say. GDP could bounce back in the second quarter of 2022, or it could continue to decline.
As of May 2022, most economists are predicting that overall GDP growth in 2022 will be low, but positive. The Fed’s GDPNow forecast predicts growth of 2.4%, and Goldman Sachs says the same. If they’re right, the U.S. will experience a slowdown rather than a full-scale recession.
The slowing economic growth in the first quarter could even turn out to be a blessing in disguise. If demand for goods and services falls off, that will help bring inflation down, reducing the need for higher interest rates.
8. Tight Labor Market
In general a tight labor market — one with a high demand for workers — is a sign of a strong economy. During a recession, businesses tend to cut back on hiring. The unemployment rate rises and wages decline as workers compete for fewer jobs.
In early 2022, exactly the opposite is happening. In May 2022, the Bureau of Labor Statistics reported a very low unemployment rate of 3.6%. And at the end of March, wages and salaries were up nearly 5% from a year before.
However, some economists worry that the labor market is too tight. They point out that higher-than-average wages are pushing inflation up. That increases the risk that the Fed will need to take strong action to bring it down and possibly trigger a recession in the process.
Avoiding Recession: Creating a Soft Landing
The Federal Reserve’s goal for 2022 is to get inflation under control without driving the U.S. economy into a recession. This is known as a “soft landing.”
To do this, the Fed will have to raise interest rates bit by bit, gradually easing off as the economy starts to slow down. It’s a bit like applying the brakes in a speeding car. It’s important to reduce the speed, but not so suddenly that you fly forward and crash into the windshield.
Achieving a soft landing is a tricky task, but not impossible. Princeton economist Alan Blinder points out that the Fed has done it at least three times before, in 1965, 1984, and 1994. On eight other occasions, higher interest rates led to recessions, but five of them were very mild.
Economists disagree on how likely the Fed is to pull off a soft landing in 2022. An April report from Deutsche Bank says inflation is so high that steep rate hikes will be needed to bring it down. The bank predicts a major recession will result, starting in late 2023.
However, other banks are more optimistic. UBS argues that the main cause of inflation is supply-chain issues that should ease off as the pandemic does. This will reduce the need for sharp rate hikes. And economists at Goldman Sachs put the chance of a recession at only 15% in the next year and 35% in the next two years.
Still, the Fed appears committed to raising interest rates. In a May interview with Marketplace, Fed chair Jerome Powell said reducing inflation is his top priority, even if a recession results.
All in all, there’s a fairly good chance that the U.S. will enter a recession in 2022 or 2023. However, that outcome isn’t certain. The Fed might still pull off a soft landing or, at worst, a mild downturn.
Still, it can’t hurt to start preparing for a recession just in case. Steps like building up emergency savings, paying down debt, and improving your credit score make it easier to weather a recession if it occurs. And they’ll also help you if the economy stays strong.