Written by Rodney Johnson March 31, 2022
A 2022/23 Recession: Possible or Inevitable?
Institutional investors aren’t crazy, although they might look that way. With Russia waging war in Ukraine and oil prices above $100 per barrel, it seems crazy that investors pushed the markets higher when the Federal Reserve announced that it raised interest rates and plans to do so at every meeting this year. But large investors weren’t looking at what will happen over the next several months, they were focused on what might occur at the end of this year and into 2023: namely, a recession.
With the world's economy being in a free-fall, can the Fed help the U.S. avoid an incoming recession?
At the Fed, the Federal Open Market Committee (FOMC) sets monetary policy. At each meeting, FOMC members submit their forecast of where certain economic measures will be in the months and years ahead. At the March meeting, the FOMC members expected the overnight interest rate that they set to reach 1.9% this year, up from a range of 0% to 0.25% before the meeting. The FOMC moved rates up 0.25% in March, which means that the committee will have to raise rates 0.25% at every meeting this year to reach that estimate. The committee members also estimate that inflation will average 4.3% this year, while GDP will fall to 2.8%.
If the FOMC is correct, then inflation still will be more than twice the rate of overnight interest rates by the end of the year, which investors took to mean that the Fed isn’t acting quickly enough, and economic growth will have fallen back to near its long-run average of the 2010s, well below inflation. When the economy grows at a significantly slower rate than inflation, we get stagflation, which harms businesses and consumers and can quickly push the economy into a recession.
Investors are betting that the Fed won’t be able to tolerate stagflation, and certainly not a recession, for long but won’t be able to bend the inflation curve, because the drivers, such as the war in Ukraine and fiscal policy, are outside of its domain. The Fed will be left with one option, to reverse course by lowering rates later this year or early next year to boost GDP growth. The yield curve tells the story.
The 10-year Treasury bond yield marched toward 2% before Russia invaded Ukraine, fell back to 1.7%, and then resumed its climb. Investors expected the Fed to be aggressive in raising rates and reducing bond holdings, both of which should push interest rates higher. When the Fed announced the rate hike, the 10-year yield jumped to 2.19%, but as investors read the full release from the Fed, the 10-year yield slid lower. In the days after the March FOMC meeting, the 10-year yield sat at 2.15% while the 2-year Treasury bond yield climbed to 1.95%, a difference of just 0.20%!
This flattening of the yield curve shows that Treasury bond investors don’t expect much GDP growth, and the corresponding higher interest rates, in the years ahead. Instead, they expect growth and rates to turn lower and, as long interest rates fall, for their bonds to go up in value.
Lower interest rates are good for stocks, because they push many investors to take more risk to achieve their goals.
Unfortunately, this leaves consumers in a tough place. The Fed is raising short-term rates, which pushes the interest rates on car loans, credit cards, and mortgages higher, and yet most people agree that inflation won’t fall anytime soon. While none of this is set in stone, one thing seems more certain than others: we’re likely to get wild swings in the stock and bond markets for the rest of the year, as the Fed, inflation, and GDP growth duke it out! Contacting your financial advisor will ensure some stability in these pressing times, and could help you prepare for a devastating recession.
If you don't have a retirement advisor to help provide solutions well beyond just making investments, and you are concerned about the impact of a recession upon your retirement, feel free to contact our office at www.CRAdvisors.com and speak to one of our advisors.
Investment advisory services offered through Mutual Advisors, LLC DBA California Retirement Advisors, a SEC registered investment adviser. Securities offered through Mutual Securities, Inc., member FINRA/SIPC. Mutual Securities, Inc. and Mutual Advisors, LLC are affiliated companies. CA Insurance license #0B09076. The information presented is not to be considered advice you can or should act upon for investment, tax or estate planning purposes without consulting with a professional to discuss your own set of unique circumstances. This article is designed to provide you with information regarding investing and planning for or during retirement. You must seek professional advice separately before acting on any items discussed in this article. The views expressed are those of Rodney Johnson and not necessarily reflect the views of Mutual Advisors, LLC or any of its affiliates. Rodney Johnson is not affiliated with Mutual Advisors, LLC or California Retirement Advisors.