Is the Economy Headed for Disaster? Here Are Possible Reasons Why.


What is the fitness level of the current United States economy?

It is a challenging question to answer correctly. The right answer is probably somewhere between “it is not good” and “it is not bad.”

But where is it heading?

The labor market appears to be holding on. With 3.6%, the jobless rate is still at levels last seen in January of 1953.

But inflation hitting 6% in February on an annual basis, it is still affecting the wallets of American consumers.

Cracks are also beginning to appear in areas like the banking sector, where businesses like Silicon Valley Bank and Signature Bank of New York have been negatively impacted by the Federal Reserve’s interest rate increases and have consequently lost the trust of their depositors. The availability of finance for small firms and even for individuals has been influenced by this.

While slowing down before January, consumer expenditure is still growing year over year.

Yet it is only the current picture. Instead, if you focus on a variety of leading indications, you might conclude that things are only going to grow worse.

Jerome Powell, the chairman of the Federal Reserve, formally recognizes this. He stated during the Fed meeting in March that the Fed anticipates the unemployment rate to increase to 4.5% by the end of 2023, which would result in well over one million Americans losing their jobs.

Powell is committed to lowering inflation back to 2% – at least that is the goal for the Fed. Along with keeping long-term inflation anchored. Giving an opportunity to restore price stability and keep employment as high as possible.

But there are a variety of signs that show a glum future.

The gap between yields on the 3-month Treasury bill and the 10-year Treasury note.

While investors seek larger reward over longer maturities, yields on 10-year notes are typically higher than those on notes with shorter durations. Yet right now, the yields are more inverted than they have been in at least 40 years. A 3-month bill currently yields 4.8%, while a 10-year note currently yields 3.5%.

Since they have occurred before every recession since the 1960s, yield inversions of these two durations are acknowledged as being an incredibly accurate recession indicator. Inversions signal a recession for multiple reasons.

One is that the 3-month yield closely tracks the fed funds rate. Financial conditions are tight and the economy will probably slow down if the fed funds rate rises to the point where the yield on the three-month note is higher than the yield on the ten-year note. On the other hand, when they anticipate an impending economic slump that will affect stocks, investors frequently swarm into 10-year notes as a safehaven asset. The price of the assets rises in response to increased demand, while the yield declines.

Second, the yield curve in the first figure serves as the foundation for the Fed’s own recession indicator, which has now reached its highest point in four decades.

Recession in the next 12 months has a 54% risk, according to the central bank. Although those probabilities may seem reasonable, a 54% possibility is significantly higher than the odds the Fed predicted in 2008 and 2001.

Keeping with bonds, the Intercontinental Exchange Bank of America MOVE Index monitors bond market volatility.

At this point, it has risen to levels last seen during the Global Financial Crisis in 2008 or so.

According to Jim Bianco, the founder of market research firm Bianco Research, the volatility reflects uncertainty among bond investors about what the Fed will do at their June meeting. 

Bianco believes the Fed does not know what will happen in June so the market will be pricing a cut, a hold and a hike.

This uncertainty arises from banks’ rising unwillingness to extend loans in the midst of the liquidity crisis that led to the closure of two banks earlier this month. He asserted that if lending declines sufficiently, the economy will enter a negative spiral. Adding, “A credit crunch, could have a very quick downturn in the economy.”

Over 45% of banks are currently tightening their lending criteria. Although it is still lower than the recessionary peaks in 2020 (71%), 2008 (83%), or 2001 (59%), the figure seems to be rising steadily.

In a similar vein, rising credit spreads are often a result of tighter lending rules. The difference between the rates on risk-free bonds and high-risk bonds is known as a credit spread.

If the spreads are wider, it indicates that investors are demanding greater rewards for taking on more risk. Greater levels of risk increase the likelihood that the businesses will fail and close, which will result in the loss of their employees’ jobs.

Now the spreads are still low, but when lending standards tighten credit spreads follow. 

A recessionary outcome would probably cause stocks more harm. Opinions on the exact amount of suffering, however, vary, in part because it depends on how severe and long a slump is.

If a recession occurs, Bianco expects the S&P 500 to bottom out at 3,500. From the index’s current level of roughly 4,090, that is a 14% decline.

The S&P 500 would fall to 3,400 in a light recession, but the index would fall to 3,000 in a heavy recession comparable to 2008, according to Bob Doll, BlackRock’s current CIO and former chief US equity strategist.

That basically aligns with recent statements made by Mike Wilson and Savita Subramanian, two of the top US stock strategists at Morgan Stanley and Bank of America, respectively. Both predict a floor for the index around the 3,000 mark, which would represent a fall of more than 26%.

There are also those who make even stronger calls. Two bubble experts, John Hussman and Jeremy Grantham, who correctly predicted the crashes of 2000 and 2008, perceive a substantial drawback. According to Hussman and Grantham, losses of over 50% are probable. Grantham recently said that this could be bigger than the setback in 2000. Which he felt was “gentle.” This current situation would be more severe because this one includes bonds and real estate unlike 2000.

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