How The Fed Is Predicting A Recession By 2023

No Soft Landing For The Fed To Avoid Recession In 2023

The Fed may be suggesting a recession is in the cards for early 2023, and I explain why.

It kind of feels like we’re in an economic twilight zone in the early dog days of summer (an actual thing and set number of days!).

If the US economy is like a poker game, then the Federal Reserve (“The Fed”) and economists are tipping their hand in penciling in a recession for early 2023 (specifically around March or May 2023).

I explain some of the latest recession signs and technical indicators that are flashing a warning for what economic mayhem could be on the horizon. Knowing these signs will help you to be prepared in case the worst comes to pass. To help us prepare, I made this recession checklist.

Moreover, we might already be in a recession based on recent trends, such as how copper prices have been sinking (a reflection of the health of manufacturing output), oil prices may have peaked for now, and mortgage rates are starting to decline. These signs suggest that consumer spending and economic output is starting to pull back.

As the Wall Street Journal reported, “if the US is in a recession, it’s a very strange one” because there’s still a lot of jobs, wages are going up, and consumers are still spending fairly strongly.

While some people could be in denial about the dark clouds looming, a recession would be kind of a big deal because if we have weakening economic growth or straight up decline plus high inflation — that could lead to depressed asset values for a while. Like our stock portfolios remaining down for a long time.

JPMorgan Chase CEO Jamie Dimon warned in early June that people only have another 6-9 months worth of spending left and then an economic hurricane could be coming. Watch that video here.

When you don’t know what’s happening in the economy, you could get blindsided and that could lead to panic selling, and you don’t want that. So the more you know, the better off you’ll be to weather whatever storm might be coming.

Sometimes people confuse and conflate economic terms together, so I clarify what recession and bear market are.

According to the NBER, a recession is defined as a significant decline in economic activity across an entire economy for more than a few months. We last saw this during the pandemic recession of March through May 2020.

This differs from the previous definition of a recession where it meant having at least two quarters of economic decline in a row. However, since US GDP contracted by 1.6% in Q1 2022, if we get another contraction in Q2 2022, we could already be in a recession if we go by the old definition when we find out Q2 2022’s economic results.

A bear market means a broad stock market index such as the S&P 500 declining by at least 20% for at least 2 months or more. While recessions and bear markets don’t necessarily happen at the same time, history has shown that usually they do.

You might be surprised to learn that the real rate of inflation is a debatable figure since the US government uses various calculations to make their projections. CPI Inflation hit 8.6% in May 2022, The Fed prefers PCE Inflation where they think it’s at 5.2% so far, and Shadow Stats used old government formulas to arrive at 15-16%. This latter figure would make more sense given how rent, housing prices, and food have risen by double digit amounts.

In order to combat higher-than-expected inflation, The Fed has been increasingly raising the Fed Funds Rate (FFR), and it’s now in the target range of 1.5% to 1.75%. However, the effective FFR is still lagging at 1.21% and hasn’t caught up yet.

While the Fed Funds Rate is the rate at which commercial banks charge each other for overnight lending, the prime rate is what we as consumers get charged for mortgages and other types of loans and it’s usually 3% above the FFR.

So we can see that recently mortgage rates have galloped way more than 3% above the lower end 1.5% FFR, and in some cases reach about 7% for 30 year mortgages if you had only “good credit” in some states. If you want shorter term mortgages like 5 or 7 or 10 year terms, then you might get rates that follow the typical prime rate amount above the FFR.

Average mortgage rates according to Freddie Mac had reached a recent high of 5.8% for a 30-year in late June 2022, and they recently fell to 5.3% in early July 2022. The last time interest rates had been near the 5% range was in 2018 before the Fed lowered interest rates in 2019-2020.

So the stock market has been declining in anticipation of The Fed hiking rates, which would depress lending since debt wouldn’t be as cheap anymore at higher rates. When corporations don’t borrow money to fuel growth initiatives as much, this could lead to declines in economic outputs like revenues as well, which likely influences analysts to downgrade these companies’ stocks.

About a week or so before The Fed raises interest rates, the stock market using the SPX starts declining before going up after the announcement of the hike is made. It happened in March, May, and June so far, and I’m venturing a guess that it’ll happen again before The Fed’s late July 2022 meeting when they are expected to announce another 75 basis point hike.

I think of the stock market’s little rises in reaction to The Fed’s actions to be dead cat bounces, and we’ll see which companies are swimming naked when the tide goes out as The Fed continues to hike rates — especially if people like Jamie Dimon and Michael Burry prove to be correct.

The CME Group has this FedWatch Tool to project how much The Fed will raise the Fed Funds Rate, and generally the rates are expected to go up through March 2023 to hit a maximum target range of 3.5% to 3.75% before The Fed might reverse course by May 2023 in dropping the rate, potentially in response to a legit recession underway by that point in time.

For now, though, as the WSJ reported, “Powell says Fed must accept higher recession risk to combat inflation,” even if it ends up hurting consumers eventually.

Fed's projections for unemployment, inflation, and fed funds rates
The Federal Reserve’s projections for unemployment, inflation, and Fed Funds rates (2020 vs 2022 comparison).

In the chart above, I compared The Fed’s December 2020 with their June 2022 projections across max employment, PCE inflation, and the Fed Funds Rate. Across these indicators, we exceeded The Fed’s goal of max employment where the unemployment rate went below their target of 4.5% and we are at 3.7% in 2022. It’s only going to get worse in their projections for 2023 and beyond.

Then, The Fed totally miscalculated inflation as their preferred PCE inflation gauge was more than 3% above the 2% target at 5.2% PCE inflation in 2022. So as they’re targeting to bring inflation down to 2.6% by 2023, this coincides with a maximum FFR at 3.8% in 2023 and then they’ll be lowering the FFR thereafter.

So just as they’re (hopefully) finally reining in inflation, The Fed will have raised the Fed Funds Rate enough to have pumped the brakes on the economy. Thereafter they’ll lower rates again in response to stimulating a depressed economy and to get more people employed again.

While I’m taking these recession signs pretty seriously, what I would say is, don’t despair and get prepared! 🙂

If you’re interested in learning how to take control of your finances and start becoming an investor like Warren Buffett, check out my free PDF guide.

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