In the ever-evolving landscape of the US economy, the Federal Reserve‘s decisions on interest rates hold profound implications for American consumers and the overall economic sentiment. As the central bank pursues higher rates, longer tack strategy, the effects are beginning to ripple through the financial well-being and perceptions of individuals and households.
This move is not without its complexities, as it balances the goals of curbing inflation and maintaining a robust economy, all while influencing how Americans perceive their financial prospects. But is a recession going to hit the US economy, or the worst is behind us?
A recession is a significant decline in economic activity that lasts for an extended period, typically defined as two consecutive quarters (or six months) of negative economic growth. During a recession, various economic indicators, such as Gross Domestic Product (GDP) , employment, consumer spending, and investment, show a decline. Recessions can have a wide-ranging impact on the economy and can lead to increased unemployment, reduced consumer and business confidence, and financial market instability.
Some key characteristics and causes of recessions include:
Reduced Economic Growth: Recessions are marked by a decrease in overall economic output, as measured by GDP. This often means that the economy is producing fewer goods and services.
Rising Unemployment: Job losses and a rise in unemployment are common during recessions as businesses cut back on hiring or lay off workers to reduce costs.
Declining Consumer Spending: During a recession, consumers tend to spend less as they become more cautious about their financial well-being.
Reduced Business Investment: Businesses may delay or cancel investment projects during a recession due to uncertainty about future demand and economic conditions.
Financial Market Turmoil: Recessions can lead to instability in financial markets, causing stock market declines, reduced lending by banks, and concerns about the stability of financial institutions.
Reduced Government Revenue: Governments often experience a decrease in tax revenue during a recession due to lower economic activity, which can impact their ability to fund public services.
Recessions can be triggered by various factors, including financial crises, external shocks (like oil price spikes or global events), excessive debt, and more. To manage and mitigate the impact of recessions, governments and central banks often implement economic policies, such as fiscal stimulus and monetary easing, to stimulate economic growth and stabilize the financial system.
The specific definition of a recession, as well as its causes and consequences, can vary from one economic cycle to another, and they are typically determined by economic researchers and organizations like the National Bureau of Economic Research (NBER) in the United States.
The United States has a rich history of economic cycles, including periods of economic growth and, unfortunately, recessions. These economic downturns have had significant impacts on the country’s financial well-being, job markets, and overall prosperity. Here’s a brief overview of some key moments in US recession history:
The Great Depression was one of the most famous and severe economic downturns in US history. It was triggered by the stock market crash of 1929 and was characterized by widespread bank failures, massive unemployment, and a general collapse of the economy. The Depression lasted for about four years and had a profound impact on American society, leading to significant government intervention in the economy.
This recession was primarily driven by a combination of factors, including high oil prices due to the OPEC oil embargo, inflation, and the end of the post-World War II economic boom. It led to a significant rise in unemployment and stagflation, a combination of stagnant economic growth and high inflation.
This recession was brought on by Federal Reserve policies aimed at curbing high inflation. It resulted in a severe economic downturn, but it was followed by a period of robust growth in the mid-1980s.
This recession was partly due to the savings and loan crisis, along with a weakening real estate market. It led to increased unemployment and a slow recovery.
The Dot-Com Bubble Burst and 9/11 Recession (2001)
The bursting of the dot-com bubble and the 9/11 terrorist attacks contributed to a brief recession. The Federal Reserve implemented monetary policy to stimulate the economy, and a recovery followed.
This was one of the most recent and significant economic downturns. It was triggered by the collapse of the subprime mortgage market and the subsequent financial crisis. The housing market crash, widespread bank failures, and a global credit crunch resulted in a deep and prolonged recession. It took several years for the US economy to fully recover.
The COVID-19 pandemic led to a sudden and severe economic downturn as businesses shut down, travel was restricted, and lockdowns were implemented to curb the spread of the virus. The US government implemented significant fiscal stimulus measures to support the economy during this crisis.
These are just a few of the notable recessions in US history. Recessions are a natural part of the economic cycle, and they can vary in their causes and impacts. The government, central banks, and policymakers often respond with various economic tools to mitigate the effects of recessions and promote recovery.
While there is no universally accepted definition, a common benchmark for identifying a recession is two consecutive quarters of contracting gross domestic product (GDP).
As of the second quarter of 2023, GDP showed a growth rate of 2.1%, and the Atlanta GDPNow model currently projects robust growth at a 5.4% pace for the third quarter. According to this widely used metric, there are no indications of an impending recession.
In the United States, the National Bureau of Economic Research (NBER) holds the official authority for declaring US recessions. The NBER’s definition of a recession is somewhat broad, describing it as “a significant decline in economic activity that is spread across the economy and endures for more than a few months.”
At the time of writing, U.S. businesses are continuing to hire and consumers are actively spending. In fact, September saw an impressive addition of 336,000 jobs, which is not a typical scenario during a US recession. While the September job growth exceeded analysts’ expectations, overall job growth has noticeably decelerated over the past year.
Investors are growing more confident in the US economy’s ability to steer clear of a recession in the coming months. A ‘soft landing,’ which represents the ideal balance between curbing inflation and sustaining economic growth, is now within reach.
Nonetheless, there are lingering concerns that cast a shadow over this optimistic scenario. Despite a prolonged trend of declining inflation, interest rates have reached their highest levels in two decades, and several economic indicators suggest that the economy might not be entirely out of the woods when it comes to the threat of a recession.
According to the New York Fed‘s recession probability indicator, there is still a 56% chance of a US recession within the next 12 months, though this is down from the 66% reading in August. Other reliable indicators are sending cautionary signals that suggest a potential economic downturn: job data displays inconsistency, the yield curve remains inverted, and experts hold divided opinions on whether a recession might have been postponed rather than completely prevented..
While the Federal Reserve has persistently cautioned that its ongoing series of rate hikes will decelerate economic growth, the most recent economic projections no longer foresee a recession. Nevertheless, even as the risk of a recession recedes, interest rates are expected to remain elevated for an extended period, which calls for investors to maintain a prudent stance in the market.
Even in the event that the US does encounter a recession in the remaining months of 2023 or early 2024, there is no need for investors to succumb to panic.
Historically, recessions have been relatively short. Since World War II, the average duration of a US recession is just 11.1 months. The early 2020 Covid-19 recession, for instance, lasted only two months.
Recessions are not uncommon occurrences. On average, there has been approximately one US recession every five years since World War II.
For long-term investors, recessions have historically presented excellent buying opportunities. While timing the market’s bottom perfectly can be challenging, the S&P 500 has generated an average return of 40% in the 12 months following the lowest point of a US recession.
Certain stocks even have a track record of performing well during recessions. Notably, shares of companies such as Target (TGT), Walmart, and Home Depot (HD) significantly outperformed the S&P 500 during both the 2020 and 2008 recessions.
The Conference Board anticipates a potential economic downturn in the United States during the early part of the upcoming year. This projection suggests a brief and shallow recession, influenced by several key factors. These factors include persistently high inflation, elevated interest rates, a reduction in pandemic-related savings, a rise in consumer debt, decreased government spending, and the resumption of mandatory student loan repayments. CB forecast indicates that real GDP growth will reach 2.2% in 2023 before decelerating to 0.8% in 2024.
Despite grappling with elevated inflation and increased interest rates this year, US consumer spending has shown remarkable resilience. However, this trend may not be sustainable. With stagnant growth in real disposable personal income, diminishing pandemic-related savings, and escalating household debt, the outlook for consumer spending growth is for a slowdown towards the end of this year, with contractions anticipated in Q1 2024 and Q2 2024. As inflation and interest rates stabilize later in 2024, a revival in consumption may occur.
Following a period of subdued growth in Q1 2023, business investment rebounded in Q2 2023, despite the upward trajectory of interest rates. This resurgence results from increased business spending on equipment, especially computing and transportation equipment, as well as elevated investments in structures, particularly within the manufacturing sector.
However, analysts anticipate this trend will gradually reverse as US consumption softens and interest rates continue to climb. Analysts anticipate one more 25-basis-point rate increase by the Federal Reserve this year, likely in November. Residential investment, which has already seen a significant contraction, may stabilize later in the year and experience growth in 2024, supported by lower interest rates and strong demand.
In 2023, government spending was a notable driver of economic growth, driven by federal non-defense spending related to infrastructure investment legislation passed in 2021 and 2022. However, the implementation of discretionary outlay reductions, as outlined in the Fiscal Responsibility Act designed to avert the debt ceiling crisis (totaling $1.5 trillion over 10 years), will constrain overall government spending and exert a dampening effect on growth in the latter part of this year and early next year.
Inflation remains a key concern, with expectations of uneven progress in the coming quarters. Energy prices have been on the rise in recent weeks, with the potential for further increases due to geopolitical conflicts in the Middle East. However, analysts expect the cooling of rental prices, which previously made a significant contribution to inflation, to have a positive impact on inflation data. Experts forecast that year-over-year inflation readings will remain at around 3% by the end of 2023, with the anticipation of reaching the Fed’s 2% target by the end of 2024.
While labor market tightness has persisted, analysts expect it to moderate over the coming quarters. However, compared to previous economic downturns, experts anticipate the labor market will remain relatively robust due to ongoing labor shortages in certain sectors and retention practices in others. This resilience should prevent a significant economic contraction and pave the way for a rebound in the following year.
Looking ahead to late 2024, we anticipate a reduction in the economic volatility that has characterized the US economy during the pandemic period. In the latter half of 2024, analysts expect an overall growth to return to more stable pre-pandemic rates. Inflation may move closer to 2%, and the Federal Reserve is likely to lower rates to approximately 4%. However, challenges in the labor market may persist due to an aging workforce, presenting an ongoing challenge for the foreseeable future.”
The trajectory of economic growth undergoes a shift, marked by initial deceleration and subsequent acceleration. Real (inflation-adjusted) GDP experiences a slowdown, with growth slowing to a 0.4% annual rate during the latter half of 2023. The year, as a whole, witnesses a 0.9% increase in real GDP. Beyond 2023, growth gains momentum as monetary policy becomes more accommodative. Real GDP demonstrates growth rates of 1.5% in 2024 and 2.4% in 2025.
The initial deceleration in economic growth leads to an uptick in unemployment. By the end of 2023, the jobless rate rises to 4.1%, followed by a further increase to 4.7% by the end of 2024. In 2025, it sees a slight reduction to 4.5%. Payroll employment trends experience a dip, with an average monthly decline of 10,000 jobs in 2024. The trend shifts in 2025, witnessing an average monthly increase of 6,000 jobs.
Inflation continues its gradual descent. The growth for PCE slows from 3.3% in 2023 to 2.6% in 2024, further decreasing to 2.2% in 2025. Multiple factors may contribute to this decline, including a softening labor market and a tapering growth in home prices, leading to reductions in certain regions and influencing rental costs.
The Federal Reserve takes steps to navigate these economic changes. In mid-2023, the Fed raises the federal funds rate, an overnight interest rate for financial institutions. From the first half of 2024, it begins reducing this rate, aligning with declining inflation. The funds rate, at 5.4% in Q4 2023, gradually drops to 4.5% in Q4 2024 and 3.6% in Q4 2025.
The most recent recession in the United States was the Great Recession, also known as the Great Financial Crisis, which officially began in December 2007 and ended in June 2009.
The duration of a recession can vary widely as there is no fixed time frame for how long a recession will last. The length of a recession depends on various factors, including the underlying causes, government policies, and the overall resilience of the economy. In the US, for example, recessions have varied in duration and the most recent one, the Great Recession, began in December 2007, lasted for about 18 months until it officially ended in June 2009. On the other hand, some recessions have been shorter, lasting just a few months. The severity of the economic shock and the effectiveness of policy responses play a significant role in determining the duration of a recession.
There have been six recessions in the US, with the first, known as The Great Depression, which started in 1929 and ended in 1933. It was followed by the 1970s Recession (1973-1975), the early 1980s Recession (1980-1981), the early 1990s Recession (1990-1991), the Dot-Com Bubble Burst and 9/11 Recession in 2001, the Great Recession (2007-2009) and the Covid-19 Pandemic Recession (2020).