Economic recessions aren’t pleasant. People lose their jobs, and many families can’t make their mortgage or rental payments. As a result, there’s less money for necessities such as food and medical care, and there’s no more money for luxuries like holidays or nights out on the town. We’ll discuss what a recession is, what causes them, and historical examples of recessions below. But first, let’s answer the question that’s top of mind – are we headed for a recession?
Are we headed for a recession?
The U.S. economy shows a few signs that we might be heading into a recession. These are:
1. Inverted bond yield curve
Typically, bonds with shorter maturities pay less than those with longer maturities. For example, three-month Treasuries yield less than 10-year Treasuries, which yield less than 30-year Treasury bonds. Long-term bond investors will accept more risk, like the possibility that inflation could erode the value of their future payments. As a result, bond issuers pay higher yields to compensate investors for this additional risk.
When there’s a yield curve inversion, short-term bonds yield more than long-term ones. An inversion of the yield curve has preceded every U.S. recession for the past half-century. As of March 14, 2022, the difference between the short and long-term yields was 0.25%. The 2-year bond yielded 1.75%, and the 10-year bond yielded around 2%.
2. A rising unemployment rate
As of February 2022, the current unemployment rate was 3.8%, and as of March 5, 2022, unemployment insurance claims were at 2.1 million.
3. An energy price increase
The surge in oil prices pushed prices at the pump higher. On March 11, 2022, the national average price per gallon of gas was $4.331, the highest ever. As Russia’s invasion of Ukraine showed, Europe is highly dependent on Russia for its energy, especially natural gas. Should supplies narrow, prices could increase rapidly. Russia could also default on about $150 billion in foreign-currency debt.
4. Rising commodity prices
Supply chain difficulties became common at the start of the Covid pandemic. For example, Ukraine is one of the world’s top corn and wheat exporters, and Russia. However, stainless steel production requires nickel, making nickel prices rise dramatically. In addition, Ukraine is a significant supplier of pig iron to Europe, resulting in a shortage. In Asia, semiconductors have been in short supply for almost a year now, causing car manufacturers worldwide to halt production temporarily.
5. Rising interest rates
According to projections, Federal Reserve officials expect to hike rates roughly six times in 2022, bringing the benchmark interest rate to nearly 2%.
The Federal Open Markets Committee expects the Fed Funds rate to be 1.9% by 2022’s end.
6. Rising inflation
According to the Bureau of Labor Statistics (BLS), the current inflation rate is at a 40-year high of 4.7% (and many other metrics calculate it as much higher). As a result, the Federal Reserve will likely raise rates from their current near-zero levels to between 1.25 percent and 1.50 percent by the end of 2022 to cool this inflation.
7. Severe drought
A drought has plagued the Western United States for the past 20 years. Scientists call it a megadrought by scientists. The region affected runs from Wyoming to the Mexican border and the Pacific Ocean to the Mississippi River. This drought will raise food prices in the United States, as farmers cannot produce crops or raise livestock.
The electricity supply will be disrupted due to 13 Western states’ reliance on hydroelectric dams for 22% of their power.
Definition: Economic Recession
A recession is a long-lasting decrease in economic activity that lasts for more than a few months. Economists use these five economic indicators to determine when an economy is on the verge of recession:
- Real gross domestic product (GDP)
- Retail Sales
The National Bureau of Economic Research (NBER), a nonprofit research organization, officially declares recessions’ beginning and end. Its definition of a recession: “A significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”
The gross domestic product (GDP) is the sum of the market value of all final goods and services a country produces during a specific period. Economists remove the effects of inflation to get “real” GDP.
GDP is typically updated yearly, but you can also calculate it quarterly. At times, GDP is negative, while at other times, it is positive. NBER keeps an eye on the four remaining components of a recession: income, employment, manufacturing, and retail sales, all reported monthly owing to these fluctuations in quarterly GDP.
What causes recessions?
Recessions happen when the following things take place:
- A real income drop: Real income (adjusted for inflation) also has removed Social Security and welfare payments. Real income drops lead to consumer spending decreases. That lowers demand.
- Decreased employment: A decrease in employment numbers and increased unemployment insurance requests can lead to recession.
- A manufacturing drop: The Industrial Production Report measures production, and when these numbers drop, recession can ensue.
- Lower wholesale-retail sales: These figures are adjusted for inflation, reflecting companies’ responses to consumer demand.
- A drop in GDP estimates: NBER looks at monthly estimates of GDP provided by Macroeconomic Advisers, and a fall can lead to a recession.
On the other hand, the behavior of the stock market doesn’t reflect a recession. Indeed stock prices are based on expected corporate earnings and show investors’ optimism or pessimism. During a downturn, the stock market may enter a bear market, which occurs when the market falls by 20% or more in less than two months. If investors lose faith in the economy, significant losses in the stock market can go hand-in-hand with a recession.
5 Stages of a Recession
A recession is an essential component of the economic cycle, also known as the business cycle.
This process is composed of five phases:
- Recession: slowing growth, employment rate falls while prices stagnate,
- Trough: the economy is at its lowest point
- Recovery: growth restarts
- Expansion: economy proliferates, interest rates stay low, and production increases; however, inflationary pressures build
- Peak: growth hits its maximum, and economic imbalances occur. Another recession will correct that.
What happens in a Recession
Manufacturing employment figures may be the first indication of an economic downturn. Manufacturers get their orders months in advance, and when that falls, so does employment. Those who have lost their factory jobs save money by reducing their spending, which has a ripple effect on other sectors of the economy.
When consumer demand drops, businesses slow down their hiring, unemployment rises, and consumer spending falls even more. At this point, firms go bankrupt, people cannot make their mortgage or rent payments, and they lose their homes. Young people, particularly recent college graduates who can’t find work after graduation, are probably the worst hit by a recession.
U.S. Recession Examples
1. Pandemic Recession of 2020
The Covid-19 epidemic occurred in 2020 and resulted in the most severe recession since the Great Depression. In April 2020, 20.8 million workers were laid off, and unemployment reached 14.7%, according to the National Bureau of Economic Research (NBER). The unemployment rate didn’t drop below double digits until August 2020.
The stock market had its version of the 2020 bear market. As a result, the Federal Reserve cut the fed funds rate to zero percent, and Congress approved $3.8 trillion in bailout money due to this crisis. In response to these actions, the economy expanded by 33.1% in Q3 2020.
2. Great Recession of 2008
The Great Recession began in December 2007 and lasted until June 2009. Then, the subprime mortgage crisis and the widespread use of derivatives sparked a bank credit crisis that soon spread throughout the global economy.
In 2008, GDP fell in Q1, Q3, and 8.4% in Q4. In 2009, GDP declined in Q1, and in October 2009, the unemployment rate hit 10%. Then, in Q3 2009, the GDP became positive, and NBER declared that the recession was over.
3. Dot-Com Bubble Recession of 2001
The dot-com recession lasted just eight months, from March 2001 to November 2001. The economy contracted by 1.1% in Q1 2001 and 1.7% in Q3 2001.
A burst in dot-com businesses was responsible for the recent recession. Companies were afraid of shifting from “19XX” dates to “20XX” dates in their computer software, but many dot-com firms were overvalued and subsequently failed. The 9/11 terrorist attack made things worse.
4. The 1990-1991 Recession
This recession began in July 1990 and lasted until March 1991. The 1989 savings and loan crisis led to higher interest rates and the Iraqi invasion of Kuwait, which led to the Gulf War. As a result, in Q4 1990, GDP dropped by 3.6%, and in Q1 1991, it fell by 1.9%.
5. The 1980-1982 Recession
This was essentially two recessions, the first from January through June 1980, and the second from July 1981 to November 1982. This recession was initiated by a push to raise interest rates by the Federal Reserve in order for it to combat inflation.
GDP was negative in six of twelve quarters in 1980, 1981, and 1982. The worst was in Q2 1980 when it fell by 8.0%. In November and December 1982, unemployment hit 10.8%, and it stayed over 10% for ten months. The Iranian oil embargo exacerbated this recession, which reduced U.S. oil supplies, driving up prices.
6. Nixon/OPEC Embargo Recession of 1973
1973 gas shortage
This recession began in November 1973 and continued until March 1975 due to the OPEC oil embargo, which caused oil prices to quadruple. The wage and price controls that President Richard Nixon implemented were also significant factors, keeping prices too high and reducing demand. In addition, wage controls kept salaries high, forcing businesses to fire employees.
President Nixon also took the U.S. off of the gold standard, causing the price of gold to skyrocket while the dollar’s value fell. The dollar’s fall led to inflation. In Q3 1973, GDP fell by 2.1%, in Q1 1974, it fell by 3.4%. In Q3 1973, GDP fell 3.7%, 1.5% in Q4, and 4.8% in Q1 1975.
7. The Great Depression of 1929
A recession is a less severe form of economic hardship, in which the economy shrinks for two or more quarters. A depression, on the other hand, is a much more serious condition in which the economy contracts for many years.
In the years 1929 to 1938, the United States suffered two recessions. Between August 1929 and March 1933, GDP fell by 12.9%, and unemployment rose to 24.7%. Unemployment remained in the double digits until 1939.
Several factors lead to the Great Depression. First, in 1928, the Federal Reserve increased borrowing rates, and then the stock market collapsed in 1929, wiping out people’s life savings. Then, a decade-long drought in the country’s breadbasket made it worse, ruining farms and creating the Dust Bowl.
The government’s New Deal boosted growth by 10.8% in 1934, 8.9% in 1935, 12.9% in 1936, and 5.1% in 1937. However, it took until the end of the drought in 1937 to end the second recession, and it was at that same time that the government increased spending before World War II.
Recessions’ impact on investors & non-investors
Investors tend to sell speculative holdings during recessions and move into more secure government bonds. Equity investors avoid risk by moving into well-established, high-quality firms with solid balance sheets and little debt. Companies with significant debt and poor cash flow may be unable to pay their debts and the cost of continuing operations.
During recessions, one of the most robust sectors in the market is basic products. Food, beverages, home items, alcohol, and tobacco are things that customers buy regardless of their financial position, and they are the last items consumers drop on their shopping lists.
Who benefits from recessions?
A recession may be advantageous to individuals who have positioned themselves to profit from economic adversity. However, history has demonstrated that predicting these events is extremely tough, if not impossible.
The Federal Reserve will lessen efforts to combat inflation during a recession when less money circulates through the economy. The Federal Reserve attempts to prevent recessions by boosting the economy via tax cuts, social program funding, and failure to consider the budget deficit.
In 2009, in response to the Great Recession, Congress passed the economic stimulus package called the American Recovery and Reinvestment Act.
The bottom line
Even though recessions are a part of economic cycles, going through them isn’t pleasant. Investors and non-investors may benefit from learning about recession signals since understanding these indicators might aid in avoiding the worst effects of a recession, such as debt repayment and avoiding speculative assets.