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Economic Report: Are recession worries overblown? Here’s why a downturn appears far off

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Sky-high inflation, rising interest rates, faltering stock prices, war in Ukraine and Chinese lockdowns — it’s enough to make investors think another U.S. recession isn’t far away.

Many economists would not be quick to agree. Future growth prospects look more unsettled now, they acknowledge, but a recession is neither imminent nor inevitable.

Why not? They point to strong financial health for both consumers and businesses and a sound banking system. During previous downturns problems emerged in at least one if not all of those three areas.

Start with households. They’ve built up historically high savings during the pandemic and have relatively little debt. By some accounts, families have $2 trillion to $3 trillion in extra savings compared to pre-pandemic times.

Consumers are the bedrock of the economy. They have secure jobs and money to spend, and if they keep doing so, the U.S. would continue to grow.

Businesses, for their part, have enjoyed record profit margins and hold plenty of capital in reserve. Their chief problem is keeping up with customer demand.

“Corporate America still looks remarkably strong,” said Christopher Smart, chief global strategist at Barings Investment Institute.

The banking system, meanwhile, is quite profitable and stable thanks in part to legal reforms undertaken after the 2008 financial panic. The 2007–2009 Great Recession was especially severe because of overlending and risky bank behavior that now seems absent.

“There are few signs of the large imbalances in the U.S. economy that have typically preceded recessions,” wrote Neil Shearing, group chief economist of Capital Economics.

Shearing disputed the notion of an imminent U.S. recession in note to clients called “From ‘Roaring’ to ‘Recessionary Twenties’ – how convincing is the market’s latest story?” He pointed out that just a year ago investors were expecting a long era of growth after the pandemic waned.

That’s not to say Wall Street
DJIA,
-0.53%

worries about recession are unfounded.

Economic headwinds

For one thing, interest rates on short-term debt briefly surpassed long-term rates recently in what’s known as an inverted yield curve. The “curve” has inverted before every U.S. recession in the past 50 years.

One caveat: The Federal Reserve has bought trillions of dollars of bonds to reduce long-term rates, potentially rendering the yield curve a less reliable indicator.

In any case, the U.S. central bank is also moving to raise a key short-term interest rate to as high as 2.5% this year from near zero at the start of 2022. The goal is to slow inflation by slowing demand and thus the economy.

Although rates are rising from a very low level, the rapid Fed hikes could still pose a problem for an economy that has gotten used to cheap money.

Lockdowns in China are a wild card.

If the lockdowns get worse and cause heavy damage to the world’s second largest economy, the effects could spill over over to the U.S. Supply-chain disruptions that have fed the worst inflation in 40 years could persist, making inflation worse and forcing the Fed to raise rates even higher.

While many economists still think a recession is at least several years away, they admit the U.S. economy is almost certain to slow.

The Fed, for example, forecasts growth to taper off to 2.2% in 2023 and 2% in 2024 from an estimated 2.8% this year. And that slowdown was predicted before central bank leaders recognized last month they would have to raise rates more quickly.

The Fed’s effort to rein in inflation — by slowing the economy — also raises the odds of a misstep if it goes too far too fast.

“Managing the path to slower growth without causing a recession will be a challenge,” said Rubella Farooqi, chief economist at High Frequency Economics.

Some economists contend a recession is still likely, though perhaps not until 2024 or beyond. Jefferies LLC noted that all 10 U.S. recessions in the last 70 years were preceded by Fed rate hikes, but sometimes it took up to a few years to materialize.

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