Will There be a Recession?

PUBLISHED Jul 8, 2022, 5:47:14 PM        SHARE

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On a roller coaster, the only way to know for sure that you've hit the peak is when you're suddenly plunging down the other side! The same holds true for the business cycle of the macro economy. After a brief-but-intense recession caused by the 2020 Covid shutdown, the economy roared into a steep expansion that was fueled by stimulus spending. Now, facing high inflation, we wait to see whether we will plunge into another recession in late 2022 or 2023 as consumers and businesses cut back on spending.

While the Federal Reserve has struck back against inflation by raising interest rates at the highest level since 1994, the June 2022 jobs report was positive news, with over 370,000 new non-farm jobs added. However, this seemingly-positive news actually caused the stock market to dip. Why would the markets be unhappy with news about unexpectedly-strong job growth? It could trigger strong interest rate hikes by the Federal Reserve as it tries to combat inflation.

Low Unemployment, High Inflation

In the short run, there is an inverse (opposite) relationship between unemployment and inflation. When inflation is high, unemployment tends to be low, and vice versa. This is because high levels of spending support lots of jobs...but this condition is only temporary. Consumers and businesses can only tolerate high spending during times of inflation for so long, and then cut back. When this reduction in spending finally occurs, businesses have to lay off employees. Now, unemployment rises as inflation decreases. Right now, the low unemployment rate is actually bad news for record-high inflation, as it signals more workers will continue spending more money.

Fed Still Needs to Reduce Borrowing

The positive jobs report is good news for investors in that it signals continued consumer and business confidence, which indicates strong demand. However, it is negative news for investors in that it signals another likely interest rate hike by the Fed. This rate hike could push the U.S. into a recession in 2023 by reducing borrowing and subsequent spending. Perhaps the most interest-sensitive sector in the economy, the housing market, is already cooling significantly thanks the Fed's 0.75 percent rate hike earlier this year. The housing market, and other durable good industries like automobiles and heavy equipment, are leading indicators that can signal broader changes in the economy.

Silver Lining: Job Market Signals Confidence

While the Fed's efforts to control inflation may trigger a recession, it's not likely to be a severe one. A shallow recession along the lines of the brief 2001 or 1991 recessions is much more likely than a steeper downturn like the Great Recession or the stagflation of the 1970s. This means that investors should continue investing normally (or even buy the dip), as the recovery - and accompanying stock market gains - will occur relatively quickly. The strong June jobs report signals underlying strength in the U.S. economy, suggesting that long-term market growth will be unaffected.

Bottom Line: Keep Investing

There are hopes that the strong jobs market will let the Fed raise interest rates without crashing the economy. Essentially, the "speed" of job growth provides a cushion against which the Fed can fight inflation. If job growth was slower but inflation was still high, the Fed's efforts would likely provoke layoffs rather than simply reduce hiring. Hopefully, reducing hiring will be enough to cool off inflation rather than having to cut existing payroll by laying off workers. But, even if businesses do cut back and a recession becomes official, it shouldn't be enough to change your investing habits.

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