Is California’s economy headed for a recession? Here’s what the experts say

More signs are pointing to an economic recession in California, if not right away, then in the near future.

Key indicators “currently suggest a heightened risk of a recession within two years,” said the nonpartisan California Legislative Analyst’s Office.

Odds are 50-50 in the next 12 months, said Sung Won Sohn, president of SS Economics, a Los Angeles-based consulting firm.

The downturn, when or if it comes, could happen “relatively quickly,” said Michael Bernick, a former California Employment Development Department director and now an employment attorney at Duane Morris LLP.

California’s fate is closely tied to the nation’s. The state’s economy, the world’s fifth largest, is deeply affected by national trends. Inflation, which is raging at levels unseen in 40 years, is threatening to stifle economic development.

Jobs are a recession’s most obvious impact. Consumers spend less and corporate sales slow. There’s less need and incentive to make and sell goods and provide services, so fewer workers are needed.

A recession is traditionally defined as two calendar quarters of economic contraction, though not always. The last recession was the COVID-19-triggered downturn two years ago.

It officially lasted two months, according to the National Bureau of Economic Research, which analyzes economic activity. That recession sent unemployment in California from 4.1% in February 2020 to 15.9% two months later. Last month’s rate was 4.6%.

Often recessions come without warning, spurred by some surprise, such as the Covid-related shutdowns, the housing crisis in the Great Recession of 2007-09 or the oil price spikes of the 1970s.

The war in Ukraine, which has helped drive up energy prices and stoke the worst inflation in 40 years, could eventually be in the category of shocks that triggered a downturn, but prices were rising fast before the Feb. 24 Russian invasion.

California recessions

Any 2022-23 recession looks to follow a more traditional path as the Fed tries to create a ‘’soft landing” that cools the economy without triggering a serious tailspin.

“Each of the economic downturns that have occurred in California since the 1980s have followed a common pattern. Unemployment is down, jobs are plentiful, and the economy looks like it will continue to prosper for a long time. The downturn, when it comes, could come relatively quickly,” Bernick said.

The Fed has raised key interest rates twice this year in an effort to cool demand and thereby curb price increases. It is expected to raise rates again in June and July.

The state legislative analyst cited several trends that are causes for concern:

▪ Home sales. They’re down as mortgage rates, roughly 3% for a 30 year loan a year ago, are now averaging about 5.25% and are poised to go higher.

April’s state sales pace was down 1.9% from March and 8.5% from a year ago, the California Association of Realtors said.

▪ Consumer sentiment. A key barometer of what people expect to spend, it’s “fallen to levels typically seen only during recessions. Changes in prices of certain U.S. treasury bonds suggest financial markets may be pessimistic about the economic outlook,” said LAO.

“Inflation and the war in Ukraine will continue to pose downside risks to confidence and may further curb consumer spending this year,” said Lynn Franco, senior director of economic indicators at the Conference Board, which surveys confidence monthly.

▪ Inflationary expectations. Prices have been rising nationally at their steepest pace in 40 years. With gasoline prices continuing to go up steadily and supply chain movement often remaining sluggish, little relief is expected.

“High inflation and tight labor markets suggest an overheated economy is struggling to find avenues for further expansion,” said LAO.

Inflation lurks

Put it all together and in the last five decades, the analyst’s office said, “a similar collection of economic conditions has occurred six times. Each of those six times a recession has occurred within two years (and often sooner).”

Fed officials insist their policies are not designed to send the economy into a tailspin.

While in the 1970s rate increases helped create a lengthy period of economic sluggishness and high unemployment, rate increases in recent years have not sparked huge downturns.

“History suggests that smooth, rather than abrupt, transitions are the norm,” Mary Dale, president of the Federal Reserve Bank of San Francisco, said last month.

Gov. Gavin Newsom’s latest budget assumes that the Federal Reserve’s tighter monetary policy will not induce a sharp economic slowdown.

But the budget released May 13 does have what officials call “shock absorbers” in case of an economic slowdown. It assumes continuing higher inflation that will mean “state services are likely to cost more than currently estimated.” And most of the spending spurred by the budget surplus is one-time only so that it can be adjusted depending on economic conditions.

Whether smooth or bumpy, storm clouds are easy to spot these days.

California’s economy has been thriving, but, noted Sohn, “rising interest rates are dampening the strength in the industries.”

“As housing losses steam, the demand for everything from paint to lumber, drywalls, furniture, appliances, etc. will suffer,” he said.

And there’s the biggest variable of all: The stuff California can’t control.

“There are several factors that threaten to stall employment growth and lead to a reversal of our decline in unemployment over the past year, including higher interest rates, inflation, and continued supply chain dislocations,” said Bernick. “These are national factors, largely outside of the state’s control.’