As the U.S. stock market capped off its fifth consecutive week of declines last Friday, analysts and investors everywhere questioned if the country was in the early stages of an inevitable economic downturn. Reasonably so, as it seems every week brings news of worsening annual outlooks and declining market conditions. Especially in the midst of a particularly brutal earnings season, it’s easy to see the forest for the trees. So, is the U.S. headed for a recession in 2022?
Well, depending who you ask you’ll likely receive grossly distinct answers. According to some, the stage has long been set for an economic slump in the west. Inflation is running at its highest levels in decades, interest rate hikes continue to spook the highest growth industries, and supply chain hiccups stemming from Russia’s invasion of Ukraine don’t appear to be easing any time soon.
Even Bitcoin (BTC-USD), once viewed as a potential hedge against inflation, is down 55% in just the past six months. It’s not alone, however; the entire cryptocurrency market has shed billions in market capitalization just five months into the year.
Since last year’s red-hot winning streak, investors have had an ever-growing list of concerns to weigh. Some of which are largely unrelated to any particular stock or business.
Treasury Yields Project a U.S. Recession
The 10-year and two-year Treasury yield curves, long considered strong predictors of recessions, have inverted on several occasions since the start of the year. Under standard economic conditions, 10-year bonds should always yield greater returns than short-term bonds. Under periods of rampant uncertainty, however, it’s possible for the two-year bond to offer a stronger return than its 10-year equivalent. This is typically viewed as an indicator that an economic downturn is on the way. Indeed, the yield curve has inverted prior to every economic recession since World War II.
It’s not a perfect science, and false alarms have occurred. Additionally, many investors believe it could take as long as two years for the full repercussions of an inverted yield curve to appear. Others view Treasury yields as the financial equivalent of astrology. Which, given the Federal Reserve’s modern manipulation of interest rates and bond prices with its quantitative easing practice, isn’t exactly a fruitless argument.
With that said, recent financial reports make it increasingly hard to ignore the writing on the walls.
Fed’s Balancing Act Could Be the Best Hope of Avoiding a Recession
The Fed has a multifaceted dilemma ahead of it. The central bank is currently tackling the issue of lowering the highest inflation in decades without slowing down economic growth to recession levels, an oft-mentioned “soft landing.”
In its semi-annual Financial Stability Report, the Fed didn’t hesitate to outline the threat posed by its interest rate hikes.
“A sharp rise in interest rates could lead to higher volatility, stresses to market liquidity, and a large correction in prices of risky assets, potentially causing losses at a range of financial intermediaries. Declining depth at times of rising uncertainty and volatility could result in a negative feedback loop, as lower liquidity in turn may cause prices to be more volatile.”
Despite the bearish wave taking over popular sentiment, there remain some bright points in the U.S. economy. Unemployment of 3.6% represents a near half-century low, putting upward pressure on wages. Others maintain that a slowdown after last year’s bullish streak is a natural aspect of the business cycle.
Regardless of which side you take, there’s no denying the potential of a U.S. recession. Understanding that fact may be the difference maker in achieving the sort of cushioned economic transition that fills Fed Chair Jerome Powell’s grandest dreams.
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