Is it Possible: Two Recessions in Two Years?

Two recessions in two years.  Is it possible?  Well, calls for a U.S. recession have been on the rise recently following the Fed’s decision to raise rates at its March FOMC meeting.  To be sure, given several factors already in play, it’s possible that we could see an economic slowdown later this year or even early next year. 

While some market watchers have suggested that policymakers could simply stop raising rates if a downturn emerges, the reality is that the Fed’s credibility and its playbook are considerably changed from where it was two years ago.

Make no mistake, at this moment, the U.S. economy is doing well.  And recent data suggest that growth has been on a solid footing since the COVID-related lockdowns eased last year.  Nevertheless, various developments related to monetary policy uncertainty and rising geopolitical tensions suggest that the road to U.S. economic growth likely will face some headwinds in the year ahead. 

Indeed, the bond market, typically a canary in the coal mine when it comes to the health of the economy, is now indicative of heightened financial and economic stress as escalating war tensions and rising interest rates have led to yield curve flattening.  And too much flattening could be an early indicator of an impending recession.

This outlook has led some investors to ask whether there is anything they should be doing now to avoid downside risks related to a market or economic downturn.  The truth is that many investors have been caught flat-footed by trying to time the markets during similar periods of uncertainty. 

And that’s why during times like these, it’s essential for driven individuals on their path to financial independence mastery to focus on an approach that has worked time and time again: consistently executing on a well-defined financial plan.

Still Solid Economic Growth?

So, how strong is the U.S. economy right now?  Well, if you were to look at some recent reports, the data suggest that U.S. economic growth has been robust over the past year.  Indeed, government data showed that the U.S. economy grew seven percent on an inflation-adjusted basis in the fourth quarter of 2021.  This gain is much faster than the average growth rate between the Great Recession and the pandemic, likely reflecting the positive effects of easy monetary and fiscal policies. 

What’s more is that recent data shows that the U.S. labor market, another important indicator of economic health, continues to improve significantly.  For example, recent initial jobless claims have declined to their lowest level since the pandemic began, and according to some reports, there are more job openings today than there are unemployed workers.  So, what does this all mean? 

Well, by looking at a solid growth print in the fourth quarter and continued robust labor market data, one could conclude that, at present, growth momentum remains positive.  Now, while it’s true that labor market shortages and falling unemployment rates are signs of robust economic conditions, what truly drives growth in this environment is business and consumer spending which are poised to decline later this year.

Slowing Growth and Rising Inflation

How can spending decline when labor market conditions have improved?  Simply put, households today are likely to face twin headwinds of higher borrowing costs as the Fed raises rates, commodity shortages and ongoing supply chain issues related to Russia’s war with Ukraine drive inflation higher.  It’s important to recall that back in 2020, policymakers unleashed unprecedented amounts of cash into the financial system as the U.S. economy stared into the abyss of Covid-related lockdowns.  Back then, trillions of dollars worth of stimulus payments allowed many businesses and households to remain solvent while the U.S. economy effectively shut down. 

With COVID lockdowns easing, and individuals returning to their usual spending routines, household consumption has been robust over the past year.  Even so, real disposable personal income, which measures how much households have left at the end of the month after paying their obligations, has fallen to its lowest level in nearly two years as the effects of inflation has bid up the prices of goods and services. 

Rising inflation has also negatively affected household confidence, falling to its lowest reading in over a decade as measured by the University of Michigan’s consumer sentiment index.  Indeed, the same survey shows that individuals anticipate inflation to remain above 4.9% over the next twelve months, which is its highest reading since the height of the Great Recession in 2008.

It’s important to note that these weaker data points were published before Russia invaded Ukraine.  Today’s high inflation arguably is tied to legacy supply chain issues coupled with too much money chasing too few goods as a result of pandemic-era stimulus measures. While Covid ground global supply chains to a halt, Russia’s war with Ukraine coupled with Western sanctions are likely to exacerbate an already challenging inflationary environment for which we’re only beginning to see the early signs. 

For example, in some parts of the country today, gasoline prices are at historic highs.  According to AAA data, diesel prices were as high as $5.25 per gallon in mid-March, besting the Great Recession peak price of $4.76 in July of 2008 and a pandemic low of $2.37.  Add to this the parabolic rise of fertilizer, wheat, industrial metals, and other commodity prices, and the inflation picture could become more challenging in the months ahead.  And this matters because households tend to consume less when prices move higher, especially when borrowing costs rise due to the Fed’s anticipated tighter policies.

Second Recession Worse than the First

Looking ahead, recent positive economic developments could give way to disappointment in the coming months.  Even though a tight labor market has led to higher wages, they’re not rising fast enough to compensate households for higher food, housing, or transportation-related costs.  At the same time, it’s becoming increasingly clear that the U.S. response to Russian aggression is not something that will be resolved in just a few weeks.  Indeed, following his meeting with NATO members last week, President Joe Biden indicated that the U.S. and its allies are preparing for a long, drawn-out confrontation with Russia (and potentially China) that could lead to a prolonged high-inflation environment. 

So, that leaves us with monetary policy.  And one question on some people’s minds is will the Fed cut rates as they did in 2020 if the economy begins to slow?  While it would be comforting to believe that the Fed could hold back on raising rates if growth slows, the truth is that policymakers likely will continue raising interest rates so long as inflation remains stubbornly high. 

Long story short, the Fed made a bad call on inflation in 2020 and waited too long to raise interest rates, so its credibility has suffered.  Now, with inflation in the U.S. increasing to 7.9% in February and cruising over five percent for the past nine months, Fed policymakers are playing catchup when supply-side pressures are poised to make their jobs more difficult.

Indeed, during its March meeting, the FOMC raised the Fed Funds rate for the first time since 2018 by one-quarter of a percent, to a rate of one-half of one percent.  While this appears to be a small move, the economy is already feeling its effect, with average 30-year mortgage rates now approaching five percent. 

What’s more, according to the Fed’s economic projections, policy rates are likely headed above two percent this year and above three percent in 2023.  At this pace, it’s very well possible that we’ve seen the end of zero-percent auto loans and mortgage rates near three percent.

Simply put, if a recession does materialize, what will make it different from 2020 is that there likely won’t be broad-based stimulus to prop up growth this time around.  You’ll recall that during the pandemic-induced slowdown, politicians were willing to dole out stimulus checks to households and businesses, and the Fed cut interest rates and expanded its balance sheet. 

This time around, however, the economic slowdown may not lead to the same kinds of bailouts as we saw a couple of years ago, naturally giving way to increased strain on households, businesses, and the financial markets alike. 

The truth is that central bank policymakers have lost credibility in their capacity to manage inflation.  Their policies either undershot in the years following the Great Recession or overshot during the pandemic.  That’s why, from their perspective, one way to make that up for the loss of credibility is to allow the economy to fall into a recession, just as the central bank did back in the 1980s during Paul Volcker’s time as Fed Chair. 

Positioning your Finances for an Economic Slowdown

Taken together, rising interest rates, higher commodity prices and ongoing supply chain issues likely will lead to slower economic growth in the coming year.  And this time around, Uncle Same probably won’t be doling out cash like he 2020.  That’s why you need to be prepared financially should a recession appear for the second time in two years.

So how should you position your finances for a potential slowdown and heightened market volatility in the months ahead?  Well, if you’re an individual focused on mastering your financial independence journey, the short answer is to stay committed to executing on your long-term financial plan.

During times of economic and market uncertainty, for some of us, there’s a tendency for our vision to narrow to the present, tempting us to change the way we handle our finances or investment allocations as a way to mitigate what appears to be an immediate financial threat. 

Even so, if you have a well-structured financial plan and a disciplined investment process already in place, then the action that you’ll likely need to focus on today is consistently doing the work necessary to execute on your plan.  If you have a well-crafted plan, those actions should be defined in your implementation schedule.  Otherwise, developing a set of strategies to align your financial resources with your long-term goals should be a priority if you don’t already have a comprehensive financial plan in place.

Indeed, a solid financial plan lays out how to connect the dots between your financial resources and ideal long-term lifestyle goals.  At the same time, it identifies predefined strategies and tactics that you can tap into to manage adverse conditions when they inevitably arise in the near-term. 

When it comes down to it, various indicators suggest that we’re likely headed for a second recession in two years.  And this time around, the government possibly won’t be as accommodating as it has been in the past.  That’s why if you’re serious about mastering your journey to financial independence, then now’s the time to ensure that you have a solid financial plan in place, that your investment strategy is aligned with your long-term plan and that you’re effectively executing on your implementation schedule.