Investing Questions Exclusively Answered by Our Experts

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How long and severe do you expect this recession to be?

While no one has a crystal ball, including us, we do have proven economic indicators that help us forecast the economy.

Based on these indicators, we believe the coming recession is likely to be one of the longest-lasting and most severe recessions in the past century.

Consumers Are Struggling

One reason we expect a rough recession is because the American consumer is already in a very weakened position.

Thanks to the Fed’s unprecedented 40% increase in the money supply in response to the government’s panic over the covid virus, the American people are suffering from the highest inflation rates in 40 years and the big increase in interest rates over the past couple of years. This has caused a drop in household incomes and an increase in poverty rates from pre-covid levels, as this chart shows.

Income and poverty

Americans also have little financial buffer to sustain them in an economic downturn. The personal savings rate is now near historical lows at 3.5%, as this next chart shows. It is only one-third the level it was at before covid and is similar to the levels it was at heading into the Great Recession of 2008-2009.

Savings rate

A recent Federal Reserve study shows that the bottom 80% of households in terms of income have less savings now than they did before covid, as this next chart shows. They estimate that “a relatively small amount—around $190 billion—remains in the overall economy, and we expect the aggregate stock of excess savings will likely be depleted during the third quarter of 2023.” That is now.

Excess savings

This is one reason why most consumers are planning to cut their discretionary spending over the coming six months, as this table shows.

Spending plans

In other words, consumers are already struggling significantly heading into the upcoming recession.

The Rise In Interest Rates Has Been Historic…And Not In A Good Way

Another reason we expect a long and deep recession is because of the historic rise in interest rates and its impact on key economic indicators.

Due to the rapid increase in short-term interest rates, the yield curve spread between long-term rates and short-term rates has been negative for the longest period of time in 40 years, as shown below. A negative or “inverted" yield curve spread has a perfect track record in predicting — and causing — recessions over the past several decades. Typically, the longer the yield curve inversion, the longer and deeper the recession.

Yield curve

Another important sign that the coming recession will be severe is that the Conference Board’s Leading Economic Index has been declining longer than in any period in the past three decades outside of the Great Recession. That is not encouraging, to say the least.

LEI

Lastly, this chart shows that historically the greater the increase in the Federal Funds rate, the greater the subsequent decline in economic activity, as represented by manufacturing new orders.

Rates PMI

Source: Trahan Macro Research LLC

Since the 5%+ increase in the Federal Funds rate over the past 18 months has been one of the largest and fastest increases in modern history, that suggests the coming recession will be one for the record books, as we first warned about back in the summer of 2021. Wise investors should be prepared.

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