We’ve seen a shrinking U.S. economy and declining economic activity, but are we in a recession?
The U.S. economy shrank in the first two quarters of 2022, and we met the historical definition of a recession. However, there is an ongoing debate about whether we’re really in one. So, are we in a recession? Is there a soft landing somewhere in our future? Or are we occupying an in-between space at the moment? Tune in as we discuss all this and more.
Hi everyone, Jay Pluimer here with Flourish Insights. As the director of investments at Flourish Wealth Management, I take pride in providing our clients, colleagues, and friends with resources and information that can help them make strategic and effective choices regarding their investments. Did you know we have an Alexa Skill? To listen on your Alexa device, just say, “Alexa, play Flourish Insights.”
Today, we are discussing if we are in a recession, if there is a soft landing in our future, or if we’re somewhere in between in a Recession-ish environment.
The US economy shrank at an annualized rate of 0.9% during the second quarter after a 1.6% decline in the first quarter. Two straight quarters of declining Gross Domestic Product, or GDP, is the historical definition of a recession, but there is a debate whether we are currently in a recession or not. The official decision about a recession is made by the National Bureau of Economic Research who has rejected the historical definition. Instead, a recession is a significant decline in economic activity that is deep, broad, and lasts for more than a few months. For example, the US economy went into recession during March and April of 2020 during the COVID shutdown, which we all felt in real time but wasn’t official until the end of the year when the National Bureau of Economic Research made the declaration.
In addition to declining economic activity, we have also been living with record high inflation. The most recent headline inflation rate of 9.1% was a new record. Despite those somber headlines, personal consumption increased during the second quarter while the economy added over 1 million jobs for the second quarter in a row. In addition, unemployment is at a historically low rate of 3.6% and wage growth continues.
Regardless of our recession status, we are definitely facing an economic crisis. An analogy I will borrow from economist Michael Lebowitz is that we have a trolley car problem. The scenario is that an unstoppable trolley car is barreling down the track. As the switchman, you stand at the junction where the track branches and you must choose which path the trolley will follow. Unfortunately, people are tied to both sets of tracks, making the decision incredibly difficult and without a clear “best” option. That’s basically the situation for the Federal Reserve, choosing between persistently high inflation and rate hikes that could trigger a recession.
Increasing short-term interest rates is designed to decrease consumer demand while reducing prices. Successfully finding a path where rising interest rates slow the economy without creating a recession is called a soft landing. There have been almost 15 recessions since World War II and more than two-thirds of the recessions were caused by the Fed raising interest rates faster than the economy could handle. At the same time, the other third of the time the Fed was able to reduce inflation with minimal negative impacts on GDP and unemployment.
As of the end of July, the Fed has raised interest rates four times in 2022, going from basically 0% to 2.25% with another 1% priced into the market for additional hikes this year. When asked to share his thoughts about the chances the Federal reserve can fight inflation without causing a recession, Fed Chair Jay Powell stated “There are a number of plausible paths to have a soft or soft-ish landing. Our job isn’t to handicap the odds, it to try to achieve that.” He compared a soft-ish landing to a bumpy but otherwise successful airplane landing.
So, basically, we are in a recessionary environment, without knowing whether or not it’s a technical recession, facing high inflation, and hoping that the Fed rate hikes can accomplish a soft-ish landing. Our perspective at Flourish is that the next few months will be bumpy, but we are optimistic that the economy and the stock market will take an upward turn later this year. There are a lot of variables to consider, so we will continue to stay proactive to position client portfolios for an eventual rebound without taking on short-term risk too soon.
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