Recession fear has been rising over the past few weeks with some investors worried the Federal Reserve, our nation’s central bank, will raise short-term interest rates too quickly, causing the economy to shrink.
Investors are concerned about this because recessions and bear markets tend to coincide. Over the past 50 years, every bear market (defined as a decline in stocks of at least 20%) except one occurred when there was a recession.
However, the data today shows that recession risk is still low. At Simply Money Advisors, we can see this by looking at leading economic indicators, which are data that moves before the economy moves. Some evidence of low recession risk includes the unemployment rate at 3.8% and falling, inflation stable around 2%, and interest rates near historically low levels.
Last week, Federal Reserve Chair Jerome Powell stressed that the case for the Fed to gradually raise rates is strong because of a robust job market and inflation near its 2% target. However, according to Bloomberg, markets are pricing in a 60% chance of just one more hike this year. If the Fed raises rates too quickly, the economy can slow down, but the bigger risk some are worried about is the current trade spat with China.
The back and forth between the U.S. and China continues to escalate with President Trump saying he is ready to impose tariffs on $450 billion worth of Chinese goods should China continue to retaliate by matching tariffs. He also said he is going to curb China’s technology investments in the U.S.
Last year, the U.S. bought $505 billion in goods from China while China bought $130 billion. This means China can’t match tariffs from the U.S. should this spat intensify, but China has other ways of striking back, such as stopping U.S. products at Chinese ports from entering their country.
The market continues to think of this rhetoric as “negotiations” that will eventually lead to a trade deal between the two countries. Unfortunately, this back and forth leaves little time for real negotiations, raising the risk of a trade war between the world’s two wealthiest nations.
The direct economic impact for the U.S. of these tariffs is minimal at around 0.2% of GDP (Gross Domestic Product), which isn’t much since the economy probably will have grown near 3% in the second quarter. The real risk is businesses pulling back on spending because of the increased uncertainty.
The Simply Money Point
The Federal Reserve has played a key role in past recessions by hiking too quickly; however, the data we look at daily does not currently point to an economic slowdown. It’s expected that China and the U.S. will eventually make a trade deal, but there’s a good chance these tensions may get worse and drag out over the summer, so be prepared for an increase in stock market turbulence.