EXPLAINER: How high is the risk of another recession?

Inflation is at a 40-year high. Stock prices are sinking. The Federal Reserve just made borrowing even more expensive. And the economy actually contracted in the first three months of this year.

Is the United States at risk of another recession, just two years after emerging from the last one?

The Fed on Wednesday stepped up its push to rein in inflation by raising its key interest rate by three-quarters of a point, its biggest increase in nearly three decades, signaling more rate hikes are on the way.

For now, most economists don’t see a recession in the near future. Despite the contraction in inflation, consumers, the main driver of the economy, continue to spend at a healthy pace. Companies are investing in equipment and software, reflecting a positive outlook. And the job market is still booming, with strong hiring, low firings and many employers eager for more workers.

“Nothing in the US data currently suggests that a recession is imminent,” Rubeela Farooqi, chief US economist at High Frequency Economics, wrote this week. “Job growth remains strong and households continue to spend.

That said, Farooqi warned, “the economy is facing headwinds.”

Among the signs that recession risks are rising: High inflation has proven much more entrenched and persistent than many economists, and the Federal Reserve, expected: Consumer prices rose 8.6% last month from to the previous year, the largest annual jump in 12 months since 1981. The Russian invasion of Ukraine has exacerbated global food and energy prices. Extreme COVID-19 lockdowns in China have worsened supply shortages.

Fed Chairman Jerome Powell has vowed to do whatever it takes to curb inflation, including raising interest rates so much as to weaken the economy. If that happens, the Fed could trigger a recession, perhaps in the second half of next year, economists say.

Analysts say the US economy, which has thrived for years on the fuel of ultra-low borrowing costs, may not be able to withstand the impact of much higher rates.

The nation’s unemployment rate is at a nearly half-century low of 3.6%, and employers are posting a near-record number of job openings. However, even an economy with a healthy job market can eventually experience a recession if borrowing becomes more expensive and consumers and businesses rein in spending.

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HOW WOULD FED RATE RAISES WEAKEN THE ECONOMY?

Higher loan rates are sure to reduce spending in areas that require consumers to borrow, housing being the most visible example. The average rate on 30-year fixed mortgages topped 5% in April for the first time in a decade and has stayed there ever since. A year ago, the average was below 3%.

Home sales have fallen in response. And so have mortgage applications, a sign that sales will continue to slow. A similar trend could occur in other markets, for cars, appliances and furniture, for example.

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HOW IS SPENDING AFFECTED?

Borrowing costs for companies are rising, as reflected in rising corporate bond yields. At some point, those higher rates could weaken business investment. If companies refrain from buying new equipment or expanding capacity, they will also start to slow down hiring. Growing wariness among businesses and consumers about spending freely could further delay hiring or even lead to layoffs. If the economy lost jobs and the public became more fearful, consumers would cut spending even more.

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DOES THE COLLAPSE OF THE STOCK MARKET HARM THE ECONOMY?

Falling stock prices may discourage wealthy households, who collectively own most of America’s stock market wealth, from spending as much on vacation trips, home renovations or new appliances. Broad stock indices have fallen for weeks. Falling share prices also tend to decrease the ability of corporations to expand. Wage growth, adjusted for inflation, would slow, leaving Americans with even less purchasing power. Although a weaker economy would eventually reduce inflation, until then high prices could hamper consumer spending. Eventually, the slowdown would feed on itself, with layoffs rising as economic growth slowed, leading consumers to scale back ever more for fear they, too, might lose their jobs.

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WHAT ARE THE SIGNS OF AN IMMINENT RECESSION?

The clearest sign that a recession might be looming, economists say, would be a steady rise in job losses and a rise in unemployment. As a general rule of thumb, an increase in the unemployment rate of three-tenths of a percentage point, on average over the previous three months, has meant that a recession will eventually follow.

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ANY OTHER SIGNS TO TAKE INTO ACCOUNT?

Many economists also monitor changes in interest payments, or yields, on different bonds for a recession signal known as an “inverted yield curve.” This occurs when the 10-year Treasury yield falls below the short-term Treasury yield. , such as the 3-month Treasury bill. That’s unusual, because longer-dated bonds typically pay investors a higher yield in exchange for tying up their money for a longer period.

Inverted yield curves generally mean that investors anticipate a recession and will force the Fed to cut rates. Inverted curves often predate recessions. Still, it may take up to 18 or 24 months for the recession to hit after the yield curve inverts. A short-lived reversal occurred this week, when the 2-year Treasury yield briefly fell below the 10-year yield, as it did temporarily in April. Many analysts say, however, that comparing 3-month performance to 10-year performance has a better recession-forecasting track record. Those rates are not being reversed now.

Powell has said the Fed’s goal was to raise rates to cool borrowing and spending to get businesses to reduce their large number of vacancies. In turn, Powell hopes, companies won’t have to raise wages as much, easing inflationary pressures, but without significant job losses or an outright recession.

“I expect this to be very challenging,” Powell said. ‘It will not be easy’.

Although economists say the Fed may succeed, most now also say they are skeptical the central bank can control such high inflation without ultimately derailing the economy.

Deutsche Bank economists believe the Fed will have to raise its benchmark rate to at least 3.6% by mid-2023, enough to trigger a recession by the end of that year.

Still, many economists say any recession would likely be mild. American families are in much better shape financially than they were before the prolonged Great Recession of 2008-2009, when falling home prices and job losses wrecked many households’ finances.

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AP economics writer Paul Wiseman contributed to this report.

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