Six Reasons Why A Recession Is Still Likely To Hit The US As Soon As This Year

With US President Biden signing a bill to fund the government until mid-November, the US has avoided a shutdown that would have been otherwise effective on October 1. But it seems that the crisis has only been averted for some time, with a recession still being expected to hit the world's largest economy.

What's Happening In The US?

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With the US government reeling under a mammoth $33 trillion debt, the story looks far from over, with the risk of recession still looming over the US. Earlier in June this year, the White House economists had warned in May that a debt default would cause the loss of more than 8 million jobs and a stock market crash. But the US had managed to breathe a sigh of relief after facing the risk of its first ever debt default and running out of cash.

Back then, in June, the Senate passed legislation to suspend the US debt ceiling and impose restraints on government spending through the 2024 election, thus ending a drama that threatened a global financial crisis.

And now, the US has avoided a total shutdown that would have otherwise occurred on October 1st. However, as per the Bloomberg report, there are not just one or two, but in fact six, reasons why the US may still fall into a recession.

Also Read: 'Problem Avoided, Not Solved,' US Averts Its First Ever Debt Default, But Only Till January 1st 2025

Why Can The US Still Fall Into Recession?

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While the last-minute deal to avoid a government shutdown kicks one immediate risk a little further into the future for the US, a major auto strike, the resumption of student-loan repayments, and a shutdown that may yet come back after the stop-gap spending deal lapses could easily shave a percentage point off GDP growth in the fourth quarter.

Add those shocks to other powerful forces at work on the economy¡ªfrom dwindling pandemic savings to soaring interest rates and now oil prices too¡ªand the combined impact could be enough to tip the US into a recession as early as this year.

Reasons why a recession remains a big possibility for the US include the wiring of the human brain and the mechanics of monetary policy, strikes, higher oil prices, and a looming credit squeeze¡ªnot to mention the end of Taylor Swift¡¯s concert tour.

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Reason 1: Soft Landing Calls Always Precede Recession

¡°The most likely outcome is that the economy will move forward towards a soft landing.¡± This is what then-San Francisco Fed President Janet Yellen said in October 2007, just two months before the Great Recession began. Yellen wasn¡¯t alone in her optimism. With alarming regularity, soft landing calls peak before hard landings hit.

Why do economists find it so difficult to anticipate recessions? One reason is simply the way forecasting works. It typically assumes that what happens next in the economy will be some kind of extension of what¡¯s already happened¡ªa linear process, in the jargon. But recessions are non-linear events. The human mind isn¡¯t good at thinking about them.

Here¡¯s an example that focuses on unemployment, a key gauge of the economy¡¯s health. The Fed¡¯s latest forecast is for the jobless rate to edge higher from 3.8% in 2023 to 4.1% in 2024. That¡¯s a continuation of the current trend and one that would see the US skirting a recession.

But what if there¡¯s a break in the trend¡ªthe type of sudden shift that occurs when the economy goes into a dive? Using a model designed to allow for these nonlinearities, Bloomberg Economics has forecast not just the most likely path for the unemployment rate but also the distribution of risks around that path.

The key takeaway is that risks are heavily skewed toward higher unemployment.

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Reason 2: Fed Hikes Are About to Bite Hard

¡°Monetary policy operates with long and variable lags,¡± American economist and Nobel Prize winner Milton Friedman famously said. One subtlety here is that the ¡°variable¡± can refer not just to differences between one recession and another but also to different parts of the economy within a single cycle.

Soft-landing optimists point out that stocks have had a good year, manufacturing is bottoming out, and housing is reaccelerating. The trouble is, those are the areas that have the shortest lag time from rate hikes to real-world impact.

For the parts of the economy that matter for making the recession call¡ªabove all the labour arket¡ªlags are longer, typically 18 to 24 months. That means the full force of the Fed's hikes¡ª525 basis points since early 2022¡ªwon't be felt until the end of this year or early 2024. When that happens, it will provide a fresh impetus for stocks and housing to turn down. It¡¯s premature to say the economy has weathered that storm.

And the Fed may not even be done hiking yet. In their latest projections, central bankers pencilled in one more rate increase.

Also Read: How The Stock Market Crash Of 1929 Led To World War II

Reason 3: A Downturn Is Hiding in Plain Sight in the Forecasts

Against the backdrop of that monetary squeeze, it¡¯s little wonder that some indicators are already flashing warning signs. Bloomberg Economics took a closer look at measures that are especially important for the eminent academics who¡¯ll officially declare whether the US is in recession or not.

That determination, by the National Bureau of Economic Research, typically isn¡¯t made until several months after the recession actually began. But the NBER¡¯s slump-dating committee identifies six indicators that weigh heavily in the decision, including measures of income, employment, consumer spending, and factory output.

Using consensus forecasts for those key numbers, Bloomberg Economics built a model to mimic the committee¡¯s decision-making process in real time. It works fairly well to match past calls. What it says about the future: There¡¯s a better-than-even chance that sometime next year, the NBER will declare that a US recession began in the closing months of 2023.

In short, if you look at the gauges that matter most to America¡¯s recession-deciders¡ªand where most analysts reckon they¡¯re headed¡ªa downturn is already on the cards.

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Also Read: World's Biggest Stock Market Crashes Of The 20th Century

Reason 4: These 6 Shocks Are Yet To Hit The US

That assessment is mostly based on forecasts delivered over the past few weeks, which might not capture some new threats that are threatening to knock the economy off course. Among them are these six:

? Auto Strike: The United Auto Workers union has called a walkout at America¡¯s Big Three auto firms, the first time they¡¯ve all been targeted at the same time. It expanded the strike on Friday to encompass some 25,000 workers. The industry¡¯s long supply chains mean stoppages can have an outsized impact. In 1998, a 54-day strike of 9,200 workers at GM triggered a 150,000 drop in employment.

? Student Bills: Millions of Americans will start getting student-loan bills again this month after the 3 1/2-year pandemic freeze expired. The resumption of payments could shave off another 0.2-0.3% of annualised growth in the fourth quarter.

? Oil Spike: A surge in crude prices¡ªhitting every household in the pocketbook¡ªis one of the handful of truly reliable indicators that a downturn is coming. Oil prices have climbed nearly $25 from their summer lows, pushing above $95 a barrel.

? Yield Curve: A September selloff pushed the yield on 10-year Treasuries to a 16-year high of 4.6%. Higher-for-longer borrowing costs have already tipped equity markets into decline. They could also put the housing recovery at risk and deter companies from investing.

? Global Slump: The rest of the world could drag the US down. The second-biggest economy, China, is mired in a real estate crisis. In the euro area, lending is contracting at a faster pace than in the nadir of the sovereign debt crisis, a sign that already-stagnant growth is set to move lower.

? Government Shutdown: A deal to keep the government open has kicked one risk from October into November¡ªa point where it could end up doing more damage to the fourth quarter GDP numbers. Bloomberg Economics estimates that each week of shutdown takes about 0.2 percentage points off annualised GDP growth, with most but not all of that recouped once the government reopens.

Framing out the broader picture, weeks of wrangling to keep the government open for 45 days doesn¡¯t seem much to celebrate.

As per a Bloomberg report, the fact that delivering the compromise means Speaker Kevin McCarthy now faces a threat to his leadership adds to the sense of uncertainty and political dysfunction.

Reason 5: Beyonce Cannot Be The Forever Saviour

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At the core of the soft-landing argument is the strength of household spending. Unfortunately, history suggests that¡¯s not a good guide to whether a recession is imminent or not¡ªtypically the US consumer keeps buying right up until the brink.

What¡¯s more, the extra savings that Americans amassed in the pandemic¡ªthanks to stimulus checks and lockdowns¡ªare running out. There¡¯s a debate over how fast, but the San Francisco Fed calculated that they¡¯d all be gone by the end of September. Bloomberg calculations show that the poorest 80% of the population now have less cash on hand than they did before Covid.

The past summer saw Americans splurge on a wave of hit entertainment. The Barbie and Oppenheimer movies and sellout concert tours by Beyonce and Taylor Swift added a remarkable $8.5 billion to third-quarter GDP. That looks like a last hurrah. With savings exhausted and concerts over, powerful consumption drivers have been replaced by a blank space.

Revealing the shape of things to come: Credit-card delinquency rates have surged, notably among younger Americans, and parts of the auto-loan market are turning bad too.

Also Read: Why Beyonce Is Being Blamed For High Inflation In Sweden

Reason 6: The Credit Squeeze Is Just Getting Started

One indicator that does have a good track record of anticipating downturns is the Fed¡¯s survey of senior loan officers at banks, known as the SLOOS, as per a Bloomberg report.

The latest reading shows that about half of large and mid-sized banks are imposing tougher criteria for commercial and industrial loans. Aside from the pandemic period, that¡¯s the highest share since the 2008 financial crisis. The impact is set to be felt in the fourth quarter of this year, and when businesses can¡¯t borrow as easily, it usually leads to weaker investment and hiring.

Now it remains to be seen whether the US is able to surprise economists and analysts by avoiding a recession or if a global financial crisis is just around the corner if the world's largest economy plunges into recession.

How Can You Be Financially Prepared For Recession?

With so much being said about the possibility of a recession, it¡¯s natural to be worried. But the least you can do is be financially prepared in case a recession indeed happens. Guarding your financial health can help you sail through such uncertain economic phases.

Eager to know how? Let us help you strengthen your finances and be better prepared for a possible recession:

1. Postpone your less important and big-ticket purchases

2. Make the creation of an emergency fund your priority

3. Turn your mundane saving habits into creative ones

4. Diversify your investment portfolio

5. Take up side gigs for passive income

6. Remain credit-ready with a good credit score if a loan need arises

7. Keep your resume updated

Click here to understand these in detail.

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