Is it too late to prevent a recession? Here's what experts say

The Federal Reserve promises to do “whatever it takes" in its fight against soaring inflation.

That may even include allowing the economy to fall into a recession, which is when the U.S. gross domestic product declines for at least two consecutive quarters.

“It’s certainly a possibility,” Federal Reserve Chairman Jerome Powell said Wednesday.

Powell made the comment in response to a question from Sen. Jon Tester, D-Mont., who asked whether interest rates that moved too high, too fast would result in a recession. Powell was in the legislative chamber giving part one of his semi-annual testimonies to Congress.

His answer on June 22 echoed remarks he made after the Fed at its most recent meeting raised its benchmark funds rate by 0.75%, marking the largest rate hike since November 1994. That brought the Fed's rate target range to between 1.5% and 1.75%.

Powell said the Fed wasn’t trying to create a recession, but admitted the pathway to a "soft landing," or a gentle slowing of the economy without significantly increased unemployment and economic contraction, was narrowing.

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Why is a recession now a possibility?

It all starts with inflation.

The Fed initially said it believed increasing inflation was "transitory.” It had expected inflation to ease once economies reopened after the pandemic, allowing goods to flow smoothly again to meet demand. That led the Fed to focus instead on recovering jobs lost during the pandemic.

Even as inflation gathered steam, the Fed still moved slowly. It increased the benchmark fed funds rate by a mere quarter point in March from near zero but continued to pump money into the economy through its emergency bond-buying program. It bought bonds to encourage easy lending.

When that didn't tame inflation, it pivoted and raised rates by 0.50% in May and began reversing its bond buying on June 1. But by then, inflation had soared. Consumer prices in May jumped 8.6% from a year earlier, hitting a 40-year high and dashing hope that inflation had peaked in April when it slipped slightly from a month prior to 8.3%.

That’s why the Fed went big in June with a 75-basis-point increase.

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What could cause a recession?

The main thing now spooking the market is the anxiety now surrounding more, and potentially bigger, rate hikes.

Because the Fed’s still behind, it has said it expects to raise rates by another 50 to 75 basis points in July and to keep raising rates with a goal of ending this year near 3.4% and 3.8% next year.

That’s much more aggressive than the Fed’s forecast in March, which predicted its funds rate would end 2022 between 1.9% and 2.8%.

It’s those faster and bigger rate hikes that economists fear could bring spending to a screeching halt. A sharp stop instead of a slow, rolling taper could lead to a recession, it said.

“With the Fed scrambling to raise rates and financial markets reeling, a recession beginning this year or next is increasingly likely,” said Moody’s Analytics chief economist Mark Zandi.

Zandi said he puts the odds of a recession over the next 12 months at 40% and evenly split over the next 24 months.

Former New York Fed President Bill Dudley was even blunter.

"If you're still holding out hope that the Federal Reserve will be able to engineer a soft landing in the U.S. economy, abandon it," he wrote in a Bloomberg Op-Ed. "A recession is inevitable within the next 12 to 18 months."

Can the U.S. still avoid a recession?

Despite that bearish outlook, there are still ways that the country could avoid a recession. But experts caution that those options are decreasing.

“There are pathways,” Powell said. “But those pathways have become much more challenging.”

For now, BMO Capital economist Sal Guatieri is leaning toward a “growth recession,” or an economy that’s growing, but so slowly that unemployment rises. Savings, about $2.3 trillion or 13% of disposable income, can support the economy, he says.

But Guatieri said that the risks of experiencing a more protracted economic struggle are plentiful.

“The economy's resilience will be sorely tested unless a lot more things start to go right than wrong in the year ahead,” he said.

“Recession odds are already elevated, given that the Fed has never achieved a soft landing (during) at least six decades when inflation was this high and the unemployment rate and policy rates this low at the start of a tightening cycle,” Guatieri said.

Add in the fastest rate hikes in decades, the potential for even more aggressive moves inflation-taming policies, and record gasoline prices siphoning money from consumer pockets, and you get a recession-ready scenario that's worrying regulators and market watchers alike.

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How's the stock market reacting?

So far, financial markets have largely been spooked by the prospect of more rate hikes to come and are anxious about not knowing how big they may be or when they might occur.

Some have even gone into a tailspin on twin inflation and recession fears, with the Nasdaq and S&P 500 index both in bear market territory, and the Dow whipsawing between major drops and regains.

Higher rates have hurt the share prices and valuations of some major S&P companies and technology juggernauts, which usually rely more on borrowing to fuel their growth. Recession and inflation fears have also hurt companies that rely on discretionary spending.

With inflation soaring and a slowing economy likely leading to layoffs, consumers may begin to feel hard-pressed to continue spending on anything other than necessities.

If the Fed’s preferred personal consumption expenditures inflation index stays around April’s 6.3% year-over-year level for another year, Guatieri estimates it will chew through a trillion dollars of purchasing power.

That is just under half of its estimated current surplus savings of $2.3 trillion.

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How may this affect consumer budgets?

The effects that anti-inflationary measures and a resulting recession could have on consumer finances are substantial.

Rates will rise on every type of consumer debt. The Fed doesn’t directly control consumer rates, but all rates – on everything from mortgages and credit cards to savings and CDs – usually follow.

For example, the average APR on a new credit card offer in early June topped 20% for the first time since LendingTree began tracking in 2018. That will likely rise further as the Fed plans more rate hikes, Matt Schulz, LendingTree chief credit analyst, said.

Coinciding with those possibilities are steepening borrowing terms in the housing market.

Freddie Mac reported that the average 30-year, fixed-rate mortgage rate spiked by 55 basis points to 5.78% from 5.23% for the week ended June 16.

“For many of those who are still planning to buy a house, higher rates combined with the high home prices that are still common around the country are likely to make becoming a homeowner considerably more expensive and difficult,” Jacob Channel, LendingTree senior economist, said.

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A shallow recession or stagflation?

The answer to whether or not we are in a recession or simply a holding pattern of low unemployment and minimal growth hinges on inflation.

If the Fed can get inflation under control with a recession, the Fed and Congress can start taking steps to get the economy out quickly, said Chris Campbell, Kroll chief strategist and former assistant secretary of the Treasury for Financial Institutions.

But if recession becomes stagflation, which is a period of sluggish economic growth with high inflation and unemployment, pain could last a while. Campbell said that's where he sees the economy headed, mostly because the factors boosting inflation right now are out of Washington's legislative hands.

“There’s not a heck of a lot Washington can do controlling COVID, Ukraine, supply challenges, and oil and natural gas challenges,” he said.

Campbell said he predicts inflation has more room to rise because producer prices continue to be high and need to work their way through to consumers.

He forecasts stagflation hitting before year-end and lasting at least four quarters.

“This will hurt the people who can afford it least,” he said. “It can be very meaningful and quite painful for a long time.”

When prices rise, they typically don’t go down again, he noted. So even if prices stop rising as fast as they have, those new higher prices will stick, and people will likely have to keep paying them.

Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her at mjlee@usatoday.com and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday morning.   

This article originally appeared on USA TODAY: Recession odds up on fear of too big, too fast Fed interest rate hikes