Economist: Recession is not a certainty but a pretty scary risk

New York (CNN Business)The American economy is super weird right now.

Pretty much anyone who wants a job can have one. The economy is so hot that prices are surging faster than at any point since the 1980s. The housing market is on fire. Consumers are spending like crazy.
Yet we keep hearing the word “recession” like it’s 2007 all over again. What gives?

The truth is that we’re probably not in recession now (although it’s possible), but there are plenty of signs that one is around the corner.

Sign 1. The Fed is hiking rates

Inflation has been rampant, and the Federal Reserve’s tool to fight surging prices lies in its ability to set interest rates higher. That makes borrowing more expensive and slows the economy down — on purpose.

The problem is the Fed was super-duper late to raising rates. Inflation was a growing concern throughout 2021, but the central bank only began hiking rates in March 2022. So the Fed needs to play catchup — and take far more drastic action than it would if it had started raising rates last year.

Last week the Fed raised rates by a half-percentage point, the biggest single rate hike in 22 years.
Fed Chair Jerome Powell said this month the central bank would continue to raise rates by half a percentage point at the conclusion of each meeting until it’s satisfied inflation is getting under control — and then the Fed would continue to raise rates by a quarter-point for a while.
The Fed is convinced it can raise rates without plunging the economy into a recession. But that so-called soft landing has proven elusive in the past, and many Wall Street banks believe the Fed will engineer a recession to overcome inflation.

Sign 2. The stock market is in sell-everything mode

Extreme fear is the predominant sentiment on Wall Street this year. CNN Business’ Fear & Greed Index is at a measly six out of 100.

After hitting record highs in early January, the stock market has lost nearly a fifth of its value — plunging stocks near bear-market territory. The Nasdaq (COMP) is already deep into a bear market. More than $7 trillion has evaporated from the stock market this year.
Concerned that higher interest rates will erode companies’ profits, investors have been heading for the exits.
That’s bad news for people’s retirement plans. It’s also unwelcome news for a number of investors who rely on the market for income, including day traders who have counted on the stock market growing in a practically straight line for the better part of the decade. And it’s not great for consumer sentiment, either.
Although a minority of Americans actively invest in the stock market, when they see a sea of red next to CNN’s ticker or on their phone screens, that has historically given people pause. Consumer sentiment dropped to its lowest level in 11 years in May.
That’s potentially bad news for the economy, because consumer spending makes up more than two-thirds of America’s gross domestic product.

Sign 3. The bond market

When investors aren’t so hot on stocks, they’ll often switch to bonds. Not this time.
Safe US government Treasuries are selling off. When bond prices fall, yields rise — and yields on the 10-year Treasury topped 3% this month for the first time since 2018.

That typically happens when the Fed hikes rates — the higher cost of borrowing makes the bonds less valuable when they mature, so a higher interest payment on the bonds (the yield) will help compensate and make them more attractive to investors.
Bonds have also sold off as the Fed has decided to unwind its massive portfolio of Treasuries that it had been purchasing since the pandemic to shore up the economy.
As bonds sold off and investors grew more fearful of an economic downturn, the gap between short-term and long-term bond yields has been shrinking. Yields on the two-year Treasury note briefly rose above those on the benchmark 10-year note in March for the first time since September 2019. That so-called yield curve inversion has preceded every recession since 1955, producing a “false positive” just one time, according to the Federal Reserve Bank of San Francisco.

Sign 4. Chaos around the globe

None of this is happening in a vacuum. Russia continues its deadly invasion of Ukraine, which has choked off supply chains and sent energy prices through the roof. China continues to lock down some of its biggest cities as Covid cases remain high. And a labor shortage has sent salaries surging and hindered the normal flow of goods around the world.
Russia continues to threaten European countries by shutting off their energy shipments, which could plunge EU economies into a recession. China’s economy has slowed dramatically as it keeps workers home as part of its zero-Covid policy.
What happens abroad could spill over to the United States, too, hurting America’s economy at the worst possible time.

What to do

OK, so a recession could be coming soon. Here’s what not to do: Panic.
Even if a recession is inevitable, there’s no telling how severe it will be. But it never hurts to plan for the worst. Here are a few ways financial advisers say you can insulate your finances from a downturn.
Lock in a new job now: With ultra-low unemployment and plenty of openings, it’s a job seeker’s market. That could change quickly in a recession.
Cash in on the housing boom: If you’ve been on the fence about selling your home, now may be the time to list. Home prices in the United States are up nearly 20% year over year, but mortgage rates are also rising, which will eventually curb demand.
Set some cash aside: It’s always a good idea to have liquid assets — cash, money market funds, etc — to cover urgent needs or unexpected emergencies.

Finally, some sage advice for any market: Don’t let your emotions get the better of you. “Stay invested, stay disciplined,” says certified financial planner Mari Adam. “History shows that what people — or even experts — think about the market is usually wrong. The best way to meet your long-term goals is just stay invested and stick to your allocation.”
— CNN Business’ Allison Morrow and Jeanne Sahadi contributed to this report.
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