Key takeaways
- Geopolitical, supply chain, and policy challenges are pushing up inflation and interest rates, which are contributing to financial market volatility.
- Despite these challenges, the US economy is continuing to grow and remains in the mid-cycle phase of the business cycle when stock prices may continue to rise despite volatility.
- A variety of factors are likely to keep the US economy from sliding into recession in the short term, including strong gross domestic product (GDP) and consumer spending, low unemployment, and rising wages.
There are a lot of reasons to worry about the economy and the markets right now. A brutal European war and the resulting economic quarantining of a major commodity producer is disrupting global supply chains that were already tangled by 2 years of public health quarantines. Central banks are hiking interest rates and ending asset purchase programs, but the inflation their previous easy money policies helped stoke to 1970s levels hasn’t shown signs of going away. Meanwhile, the chance of policy error lurks as the Fed tries to raise rates far enough and fast enough to tame that inflation.
Still, Fidelity's Asset Allocation Research Team (AART) does not think recession is imminent. Research Analyst Cait Dourney says that the Fed's plan to raise rates at a faster pace than they did in the last few decades "poses a risk of slowing down the economy, say later on in 2023." But for now, she says the US remains solidly in the middle of the business cycle, when the economy is growing and stock prices may continue to rise despite volatility. Indeed, there are many signs that say the current economic expansion isn't near its end.
At the start of April, yields on 10-year US Treasury notes fell below yields on 2-year notes for the first time since 2019. Twitter and legacy media alike overflowed with claims that this “inverted yield curve” was a sign that recession was imminent.
It is noteworthy whenever yields on bonds that mature in the relatively near future rise higher than those of bonds that mature at a more distant point in time. However, history shows that an inverted yield curve forecasts recession much in the same way that autumn forecasts winter: While one eventually follows the other, nothing indicates when the snow will start falling. Indeed, the length of time between the inversion of the curve and the onset of recession has historically varied from as little as 6 months to as long as 4 years, says Director of Quantitative Market Strategy Denise Chisholm.
Dourney agrees that an inverted yield curve is typically a good indicator of a future economic slowdown or recession but notes that there are many parts to the yield curve and that not all of them are saying the same thing. While the inversion of the curve between yields on 2-year Treasurys and 10-year Treasurys triggered a tsunami of recession predictions on social and mainstream media alike, Dourney says that many of those opiners were looking at the wrong part of the curve. "Our research has found that the 3- month versus 10-year part of the yield curve has historically been the best predictor of whether a recession is near. At this point, that part of the curve still remains quite steep and is not signaling a recession."
While the curve is sending mixed messages, other data is giving strong and reliable signals that the US is unlikely to tip into recession anytime soon. The Asset Allocation Research Team says the US remains in the mid-cycle phase of an economic expansion that began with the end of the brief COVID-19-provoked recession of 2020. History shows the mid-cycle can continue for years while recessions on average have lasted only 9 months.
The US economy remains strong
Far from slowing, current US gross domestic product (GDP) is growing at the highest rate in nearly 40 years. In 2021, GDP growth was 10% before adjusting for inflation; 5.7% after adjustment. This is the highest since 1984, when the US was emerging from a deep recession engineered in part by Federal Reserve Chairman Paul Volcker, who pushed interest rates close to 20% in order to end a decade of high inflation.
Seventy percent of this strong economic activity is the result of consumer spending. No matter how gloomy consumers claim to be about the economy, they continue to fuel the expansion by spending their money. Monthly personal consumption expenditures reached $16.7 trillion in February. Consumers spent $14.8 trillion the month before the pandemic lockdowns, which fell to $12 trillion in mid-2020.
Worried consumers can push the economy toward recession when they cut spending. Today’s jobs data, though, suggests they have little to fear. The unemployment rate in February was 3.6%, down from a high of 14.7% during the tightest lockdowns early in the pandemic. This is nearly back to where it was before the pandemic. At the same time, the number of job openings is at a historically high level, with 11.3 million job openings reported in February.
But what about oil?
Part of the anxiety about what’s ahead is being fueled by high oil prices. That’s putting noticeable pressure on many people’s budgets, even though energy is not included in the consumer price index that media reports often equate with inflation. Despite the pain at the pump, though, energy prices matter less to the health of the economy than they did in the 1970s when they helped cause and prolong stagflation. Then, the US was an oil importer and the economy was still based on energy-intensive manufacturing. That left the US acutely vulnerable to higher oil prices after the Organization of Petroleum Exporting Countries (OPEC) cut off shipments to the US during the 1973 war between Israel and its neighbors.
More than 40 years later, the US can produce as much oil as it needs and price spikes or supply cuts are less of a threat. While the price of oil has been volatile over the past year, the chance of a 1970s-style oil shock appears minimal, according to Fidelity’s Asset Allocation Research Team. Indeed, Chisholm says that oil prices would need to stay between $140 and $150 per barrel on a sustained basis to create the type of a shock that historically has been capable of tipping the economy into recession.
How should you invest now?
The evidence that recession is not imminent is strong, but investors—like consumers—may remain anxious. Stock market corrections like those we’ve seen so far this year have historically been typical for years when mid-term elections are held and they often have been followed by strong market rallies. Strong rallies have historically also been common following times like now when there has been widespread uncertainty about the direction of interest rates or other government policies. And when the curve has inverted in the past, stocks have returned almost 10% in the following year, says Chisholm.
In this situation, says Claus Te Wildt, strategist with Fidelity Capital Markets, investors may want to continue to diversify their investments, both within their overall portfolios, but also within each asset class.
