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Savings, business reopenings are key to preventing a severe recession

While the U.S. economy teeters on the edge of a recession, promising buffers for severe outcomes still exist, according to economist Alessandro Rebucci

The U.S. economy may have already entered a recession, but it may not be as dire as what some economists have predicted, even after the Federal Reserve raised interest rates on July 27. The increase marked the third interest rate hike aimed at curbing inflation, bringing the policy rate to a range of 2.25% percent to 2.5%—the highest level since 2018.

A recession, according to Alessandro Rebucci, associate professor at the Johns Hopkins Carey Business School, is defined as two consecutive quarters of negative gross domestic product growth. U.S. GDP was negative in the first quarter of 2022 because of falling exports, particularly to China, and it has decelerated further, according to the Atlanta Fed GDP Nowcast.

Still, Rebucci is optimistic that the interest rate hike, a slowing Chinese economy, and the troubled Eurozone economies will not drag the U.S. economy down; rather, he's expecting that the U.S. will experience a "mild recession."

Good news

Rebucci says there are at least three reasons to be optimistic about the U.S. economy.

Consumers are drivers of the U.S. economy, and they are still spending. Rebucci adds that households still have a $2.5 trillion cushion of savings, accumulated during the height of the pandemic. According to the U.S. Bureau of Labor Statistics, the personal saving rate averaged 7.5% from 2015-2019, but grew to roughly 15% during the pandemic, allowing consumers to amass a stash of cash or so-called "rainy day" funds. That increase in savings will allow households to better withstand the coming slowdown, Rebucci says.

"The economy is already slowing, energy prices are falling, and, barring another round of shutdowns in China, supply chains are slowly normalizing or adapting to the pandemic and geopolitically fragmented new world economy."
Alessandro Rebucci
Carey Business School

The same logic applies to businesses. Firms are sitting on large cash balances and currently don't depend on credit or the stock market to finance their expansion plans. CEO surveys show that executives are more worried about the broader economy than their own business, suggesting that they are concerned about inflation and the Federal Reserve's response, but are not seeing clouds on their horizons.

Unlike in China, the U.S. economy continues to reopen and has stayed open despite a new COVID-19 wave buffeting the country. Full resumption of economic activity in the service industries will provide support to any employment losses in sectors more exposed to slowing international trade and the tapering of expenditures on goods during the pandemic.

Mandated lockdowns, mass testing, quarantines, and border closures forced major big-box retailers, including Walmart Inc. and Target Corp., to bulk up on inventory last year to avoid lengthy shipping delays. Both corporations are now sitting on inventories of $45 billion, up 26% from a year ago—a welcome sign that normalcy is returning.

And while there are still pockets of weakness in the service industry, there are plenty of signs of improvement.

Travel and hotel stays have normalized. TSA statistics show that domestic travel over the Fourth of July weekend neared pre-pandemic levels. More than 2 million travelers passed through airports, while only 175,000 travelers were counted in 2020. According to an official Times Square pedestrian count, 353,576 people visited the tourist attraction each day this week, compared to 125,000 daily visitors in 2020.

Nonetheless, markets are currently pricing another 75-basis-point hike, bringing the benchmark rate about two-thirds of the way where they and the Federal Reserve currently expect it to peak in 2023. In other words, Rebucci says, the end of the tightening cycle is in sight and the risk of an overreaction to the Federal Reserve's action is diminishing. The economy has not tanked yet, and is unlikely to do so at this point in the tightening cycle.

"The economy is already slowing, energy prices are falling, and, barring another round of shutdowns in China, supply chains are slowly normalizing or adapting to the pandemic and geopolitically fragmented new world economy," Rebucci says.

Major risks

Major risks are not stemming from the U.S., but are rather global. Rebucci notes three key areas of note as we navigate through 2022.

The Eurozone is just starting the tightening cycle and may have to stop due to political instability in Italy—its third largest economy threatening the monetary union once again.

European Central Bank President Christine Lagarde announced on July 21 a first-rate increase for the first time in 11 years, bringing the policy rate to zero, and a new bond purchase program to protect member states under speculative attaches on their sovereign debt. The ECB, which, unlike the Federal Reserve, could focus solely on inflation, has set itself up to pursue two objectives that are difficult to reconcile: tightening monetary policy to tame inflation, and loosening it to prevent that tighter monetary policy damage to the monetary union. The risk of a second Eurozone crisis is material, and that would put headwinds on the U.S. economy, even though it may not drag it down.

China: When COVID-19 cases inevitably rise again, the Chinese government will likely shut down parts of the country, including the financial center of Shanghai and its export hubs.

"COVID-19 will come out of the box again, and shutdowns in China are quite likely," Rebucci says. "A shutdown in China means major disruptions to the supply chain, and more persistent U.S. inflation."

War in Ukraine: One of the biggest factors in the global economy will be how countries adjust to the war in Ukraine going forward. The unpredictability is having a larger impact than first expected.

Russia's invasion of Ukraine has led to numerous global supply chain issues including food staples like wheat and energy.