It’s the big question that has been looming over the financial markets for months: Will we or won’t we enter a recession?
It has been 16 months since the Federal Reserve started its aggressive strategy to break high inflation levels through a series of interest rate hikes. Yet, the U.S. economy appears to be on firmer ground than most market watchers would have predicted at the beginning of the year.
It’s clear that nominal U.S. economic growth is cooling from its peak of a couple years ago. When adjusted for inflation, the initial reading of real gross domestic product growth for the second quarter of 2023 was 2.4%, slightly down from the 2.6% rate at the start of the year.
The Fed has been consistent in its focus toward fighting inflation even at the expense of weakening the labor market and wages. While there has been some moderation in wages, we’re still adding jobs at a healthy pace.
In June, 209,000 jobs were created, according to the monthly employment report from the U.S. Bureau of Labor Statistics. Historically, the U.S. economy has never entered a recession while job growth is occurring, and our robust labor market is arguably the biggest reason the Fed may engineer a soft landing of the economy and avoid a major economic downturn.
At the same time, the Fed has had success in cooling the pace of inflation. The consumer price index slowed to 3% in June, a considerable drop from its peak of 9.1% in June 2022.
Inflation has slowed this year due to falling food and energy prices but remains far above the Fed’s 2% target range.
Inverted yield curve
While employment has remained strong and inflation has moderated, other economic measures paint a different picture. Market watchers are increasingly focused on the current inversion between the yield spreads of the 10-year and two-year Treasury notes, which have been consistently inverted for a year. Every recession since 1955 has been preceded by this type of yield curve inversion, making it one of the most reliable forecasts of the economy.
In addition, the leading economic indicators, a set of metrics used to help predict future economic activity, have been declining over much of the year. It’s also hard to ignore that we have experienced the quickest expansion of interest rates since 1980. It typically takes 12 months for the full effect of a single rate increase to work its way through the U.S. economy. With the Fed raising rates 11 times in 16 months, it will take some time for us to realize the full impact of this strategy.
If we’re looking to the capital markets for guidance, there too we see a lack of consensus. The S&P 500 is up over 28% from its lows in October 2022. That doesn’t appear to be a fear of recession but more of an indication the stock market expects the Fed may be close to ending this historic rate hiking cycle. Meanwhile, the bond market – and the inverted yield curve – still are predicting a hard landing for the economy.
But back to the main question: Will we, or won’t we? My colleagues and I believe a recession is still likely to happen in late 2023 or early 2024. Regardless of the possible timing, one thing is certain: This is an ideal time to talk to a financial adviser. These professionals are available to help you navigate the volatility of the current environment and keep you heading toward your financial goals.
Don Davis is a senior portfolio manager for Commerce Trust Co. in Springfield. He can be reached at firstname.lastname@example.org.
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