According to Momentive’s CNBC + Acorns Invest in You survey, 81% of adults think the U.S. economy is likely to experience a recession. With social media abuzz with plenty of tips and *hot-takes*, plus debate over indicators like rising interest rates, it’s time for a conversation about how to prepare for a potential recession.
We all want to make sound financial decisions. Essential to this is understanding where we are in the business cycle (expansion, peak, contraction that could turn into a recession, and trough), how the economy is doing, and where it might be headed.
Let’s start with the basics.
First, what is a recession?
A recession is typically defined as two consecutive quarters of negative economic growth, measured by a country’s gross domestic product (GDP). While GDP is the most common way to measure a recession, other indicators include higher unemployment rates, rising interest rates, and lower stock market prices. In short, it’s when the economy as a whole slows down.
Various factors can cause recessions, including tight monetary policy, high interest rates, a housing market crash, an oil price shock, or even a war.
How likely is it that the U.S. will have a recession?
Let’s look at some of the indicators that drive the economy. We’ll break this down into two separate sections and give you an overview of both.
Economic indicators are economic statistics like the unemployment rate, GDP, or inflation rate that suggest how well the economy is doing now and how well it might be doing in the future.
Pro-cyclic indicators are economic indicators that move in the same direction as the economy. If the economy is doing well, these numbers typically increase. Conversely, these numbers typically decrease during a recession.
Examples include retail sales, industrial production, new orders for durable goods (like appliances), number of employees on nonagricultural payrolls, and GDP.
Leading economic indicators are economic statistics that change before the economy changes. On account of this, they help predict how the economy will do in the future.
Examples include the stock market, the number of new building permits, and the consumer confidence index.
Let’s take an in-depth look at some of these indicators.
How are consumers spending?
Consumers cut back (or spend less because of job losses or economic insecurity) when they have less to spend. What’s the problem with that? Well, declining consumer spending undermines prospects for recovery.
But, only a smaller portion of our economy is cutting back.
Higher-income consumers are showing signs of financial stress by reducing their spending on dining out, travel and vacations, and cars. However, that’s not the complete picture.
Consumers are still spending despite inflation
Studies show consumer spending generally rose faster than inflation for a third consecutive month. Despite inflation’s pressures, more people continue to spend more.
Rising Interest Rates
Because inflation is running so high, the Fed has to hike interest rates to levels that haven’t been seen since 2009. In April 2021, the average home loan rate was below 3%. Today, it’s at 5.25%.
While this hits people looking to purchase a home, rising interest rates also impact businesses.
How do interest rates increase the risk of recession?
As lower consumer spending can hit the economy, so too can reduced business spending. When borrowing costs for businesses rise, companies slow how much they purchase, avoid expanding capacity, and reduce hiring. These effects (combined with wage growth due to inflation) could lead to layoffs.
Unemployment Rates
With the nation’s unemployment rate at a 50-year low of 3.6% and companies posting record-high open jobs, how could we still be at risk of a recession? According to the experts, an average increase in the unemployment rate of .3% over three previous months has meant a recession will follow.
We’re not there yet. So what are we seeing?
Falling Stock/Commodities Prices
On May 9, 2022, tech stocks like Apple (-3.3%) and Amazon (-5.5%) were down. Boeing was down 10.5%. With Bitcoin dropping 8% and the total crypto market cap sinking over 10%, not even cryptocurrency gave investors a respite from the sinking markets.
It’s natural to feel an immediate sense of panic when markets dive. Seeing our portfolios dropping and our hard-earned savings seemingly evaporating before our eyes, we can’t help but feel overwhelmed and scared.
But things are constantly changing. To stay up to date and assess how likely a recession is, look out for these other indicators:
- GDP and jobs
- Pro-cyclic stats like inflation and interests rates
- Counter-cyclic states like unemployment (or even gold prices)
- Consumer confidence index
- Interest rates, including the federal funds rate
In addition to knowing how to prepare for a recession, take the next step and be prepared. A recession can have a massive impact on your finances. Without being well-prepared for a recession, you may find yourself in debt or even unemployed. Next, let’s get into a few recession-based tips.
How do I prepare for a recession?
Here are some basic tips for recession preparation.
1. Build up an emergency fund. Ideally, an emergency fund has 3-6 months of savings. In reality, most households cannot save more than a month or two. In just three weeks, nearly 17 million Americans filed for unemployment due to the financial crisis brought on by Covid-19. An emergency fund gives you money to live on if you lose your job or have unexpected expenses. Plus, a crisis budget can help you stretch your cash.
2. Pay off your debt. Reduce your monthly expenses and increase your financial flexibility. As PennyUpgrade points out, “Our first step [to tackling debt] was to actually find a way to track it. After stumbling onto a financial management app, we learned our most valuable lesson, give every dollar a job. We made categories for every single expense and tracked every dollar. By doing this, we had a clear picture of our finances and where we were spending our money. After a while, it becomes easier to see where you can cut spending.”
3. Invest in yourself. Recession-proof your career by taking courses, learning new skills, or networking. There are free or cheap ways to learn new skills and develop professionally without the help of your employer.
4. Live below your means. It’s easier to stress less when you have more money to spend. Understand where you are and how much income is coming in. Then, ensure you can cover your expenses. Basic steps to money management will help you save more and stress less.
5. Stay diversified. Don’t put all of your eggs in one basket. If you jumped on the crypto bandwagon, but didn’t invest in the S&P500, now might be a good time to diversify your assets. This helps protect yourself from the impact of a recession.
Protect yourself financially
While the United States has experienced several recessions over the past few decades, there are ways to limit the impact a recession can have on your finances. Some tips include saving extra money now to help cushion the blow if you lose your job, or investing in recession-proof stocks.
By following these recession tips, you’ll know how to be prepared and protect yourself from any financial impacts.
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