The US economy is the largest in the world and might enter a recession in the upcoming months. This would be an artificially induced one, a result of the Federal Reserve raising rates in 2022 to fight inflation.
One of the major signals of an upcoming recession is the yield curve inversion. When shorter-term government bonds have higher yields than long-term, a recession usually follows in the upcoming months.
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Inversions along parts of the US yield curve already signal a recession. For example, as the chart below shows, the three-month and two-year interest rates are below the 10-year rates. Whenever this happened in the past, a recession followed.
As a result, more than 60% of economists surveyed by Bloomberg expect a recession within the next year. The big question is – how severe would it be and what would happen to other economies?
Higher rates affect the US housing market
The steep tightening affects the housing market via mortgage rates. The good news is that it is accustomed to locking in a loan with a fixed rate in the US, so the tightening cycle does not affect those who bought a house when interest rates were low. But the bad news is that higher rates lead to falling house prices, as new buyers are scared of the current rates.
The indirect effect would be that confidence will be hit hard as the wealth effect dissipates.
Where would the Fed’s terminal rate be?
The answer to the recessionary fears lies with the Fed. More precisely, where would the Fed set the terminal rate?
Most economists expect the US recession to start in early 2023 and be just mild. One of the reasons for it to be mild is that the consumer is still resilient.
Another one is that the Fed’s terminal rate is seen at 5%-5.25%, meaning that the tightening cycle should end relatively soon.
All in all, the full impact of the Fed’s monetary policy in 2022 will be felt in 2023. A mild recession was the Fed’s bet, but some indicators are lagging (i.e., the unemployment rate), so no one knows when the recession will start, how long it will take, and what the secondary effects would be.
