Why the Federal Reserve of New York Expects a Recession in 2023
Deep recession, soft landing, or no recession at all? No one knows for sure.
- By comparing the yield spread between long-term and short-term Treasury bonds, the Fed can predict the likelihood of a recession occurring within 12 months.
- Since 1959, the Fed’s method of predicting an upcoming recession has only been wrong once.
- There are steps you can take to prepare for any economic downturn, such as bringing in extra cash, building your emergency savings, and paying down debt.
Despite record-low unemployment, a recent surge in consumer spending, and a slow decline in inflation, the Federal Reserve of New York has reservations about the health of the economy. Here, we explain why the Fed expects a recession sometime in the next 12 months and what you can do to protect your finances.
Typically, analysts look at a small bundle of macroeconomic indicators to predict the likelihood of a recession. One of the most relied-upon indicators involves the Treasury bond yield curve. Here’s how it works.
It indicates a healthy economy
When the economy is healthy and humming, the Treasury yield curve slopes up and to the right. What this means for investors is higher yields on bonds with longer-dated maturities. For example, a 10-year bond will offer a higher yield than a two-year Treasury bond. The longer an investor keeps their money tied up in the bond, the more they can expect to receive when the maturity date arrives.
It indicates trouble on the horizon
When analysts notice that the Treasury yield curve flattens or becomes inverted, trouble could be brewing. Currently, the curve is inverted, meaning that investors can expect a higher yield on short-term Treasury bonds than on long-term ones. The fact that investors are so concerned about the U.S. economic outlook that they don’t want to tie up their money for long serves as a flashing red light.
Nearly perfect record
Since 1959, the Federal Reserve Bank has used the yield spread between the 10-year and three-month bond rates to calculate the odds of a recession occurring within 12 months.
What the Fed is looking for is a probability of recession greater than 40%.
To date, the probability has exceeded 40% eight times. The forecasting tool has not been wrong except for a probability of recession of 41.14% in October 1966. In December 2022, the likelihood of recession hit 47.31%. As far as the Fed is concerned, it indicates an economy poised to slow over the next 12 months.
Historically, the Federal Reserve stepped in to rescue the economy when things got shaky. To steady the situation, the Fed conducted rate-easing cycles to bring down interest rates and spur economic activity.
With inflation coming down at a snail’s pace, the Fed announced plans to continue raising the interest rates until data provides confidence that inflation is on a sustained downward path to 2%. In the meantime, with borrowing costs at their highest since 2007, it’s difficult to imagine how the surge in consumer spending can continue or how long the wait for a 2% inflation rate will take.
How you can prepare
As challenging as it might be, take heart. If a recession does occur, it will be the 14th in the U.S. since the end of World War II. The average recession has lasted 10 months. On the other hand, periods of expansion have lasted an average of 57 months.
In the meantime, here are concrete steps you can take to prepare for whatever is around the next economic corner:
- If you don’t have one already, focus on building an emergency fund. While you’ll want to aim for enough money in the fund to cover three to six months’ worth of bills, it could take years to get there. Let’s say you manage to squirrel away $1,500 over the next few months. That’s an extra $1,500 to cover things like a surprise tax bill or higher-than-average utility bill.
- Whittle away at high-interest debt. If you’re living paycheck to paycheck, paying down high-interest debt while building an emergency fund may seem impossible. This is where you can cut back on unnecessary expenditures, like expensive cable TV packages, and use the money to get a chunk of debt off your plate.
- Find creative ways to bring in extra cash. Have a garage sale, become a tutor, provide after-school care to neighborhood kids, or look for another way to earn money. If you have trouble coming up with an idea that appeals to you, there are apps available that can help.
- Buy and hold your investments. If you’re investing for the future, you may be tempted to sell off as the market drops. Ignore that urge. When the market dips, you can scoop up the best deals. Then, as the market invariably recovers, your portfolio grows.
No one can predict the future, including whether a recession will occur. And if a recession does hit, no one knows whether it will be severe. NPR spoke with Justin Wolfers, an economist at the University of Michigan, who says that all the recession talk seems absurd.
Wolfers predicts a soft landing, with demand for items dropping off just enough to encourage companies to lower prices. Not enough that they would lose money, but enough to reduce inflation.
Wolfers’ reason for optimism is unemployment at a 50-year low, a rate earlier generations of economists considered impossible.
A deep recession, soft landing, or no recession at all — it’s out of our control. What we can control is how prepared we are for whatever comes our way, and that starts with saving for a rainy day.
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