The economic data shows evidence of an economy in transition. The raging debate is whether the economy is transitioning to a slower growth rate (i.e., a “soft landing”) or whether it is transitioning to a recession (i.e., a “hard landing”). 

During a transition period, economic data is often conflicting. As a result, those who believe in a soft landing can find data that support their beliefs while those who believe a recession is imminent can find data that support their beliefs. The one thing that remains constant is that a recession is the last stage of an economic cycle and there is no evidence that the cycle has been broken. 

The question is, when will it occur? There are two challenges facing businesses and individuals that should be monitored in an effort to answer that question. 

Spending by Borrowing

Individuals and business who have maintained their spending habits by taking on debt are now facing the challenge of rising interest expense on that debt. This is especially true for variable-rate debt. The most recent data from the Federal Reserve show that the average interest rate on credit card accounts that carry a balance and have interest assessed is 22.77%. Lenders are also making it harder to borrow for both individuals and businesses. 

The most recent data from the Federal Reserve also show that an increasing number of financial institutions are increasing the spread over the base lending rate and raising the standard needed to qualify for a loan or credit card. As rates rise and standards increase, fewer people and businesses will be able to borrow to fund spending. This will slow spending and economic growth. The question is how much?

Inflation-Measured and Unmeasured

“Core” inflation, as measured by the Bureau of Labor Statistics, is still at a 4.1% annualized rate as of Sept. 30, 2023. The Federal Reserve’s target is 2.0%. This is why the Federal Reserve continues to communicate that its work is not done and that interest rates will have to stay higher for longer to bring inflation down. 

For the average consumer, their “core” inflation rate is not the same as the official measured inflation. The core items that most consumers buy are food, energy, shelter, and daycare (for working families). Food prices were up 3.7% year-over-year. Energy prices were down 0.5% on a year-over-year basis but up 5.6% on a monthly basis in August and 1.5% in September. 

If you had a lease coming due for the apartment or house you live in, shelter prices were up 7.2% year-over-year and, for those who have daycare expenses, daycare costs were up 4.8%. For many lower- and middle-income families, these price increases are what have forced them to use credit cards to pay their bills. 

The unmeasured (i.e., not counted in the official inflation measure) inflation is also a threat to economic growth. Housing prices remain unaffordable in many states. If the average worker cannot buy a house, then they remain subject to rising rental rates. Wage increases are another unmeasured inflation source that could threaten economic growth. As long as businesses can push through wage increases to the cost of their goods and services, inflation remains a problem. This is called a wage-price spiral.

Conclusion

The key is to believe what you are seeing or experiencing, not what the media is telling you. If times are good for you, keep doing what you are doing, but remain alert and prepared. Whether a recession happens in the next three months or the next three years, preparing for a recession remains critical. The time to prepare for a recession is while times are good not when times get bad.

Steve Scranton, CFA, is chief investment officer and economist for Spokane-based Washington Trust Bank.