To use a weather analogy, I believe we are under a “recession warning” as the Federal Reserve continues its aggressive interest rate increases. I now believe that the risk is high that the economy will be in a recession before the end of 2023.

The Federal Reserve has already raised the overnight borrowing rate 3.75% since the beginning of the year, and the communication continues to be that it will continue to raise rates until there is clear evidence that inflation is declining. 

The important part of its communication is when it says it will continue to raise rates even if it causes pain for the economy. I interpret the “fed speak” to mean that it will raise rates even  if it causes a recession (i.e., economic pain).

Higher interest rates do cause economic pain:

• Interest sensitive sectors of the economy, like the construction industry, are hurt as rising interest rates eliminate many buyers for the residential construction industry and make many projects no longer feasible for the commercial construction industry.

• Interest rates on any variable rate debt that a consumer has will continue to rise as the Federal Reserve is raising rates. Every dollar of increased interest expense is a dollar less available to spend. Credit card debt is variable rate.

• Businesses who borrow to fund their operations will see their interest expense rising. The Prime lending rate has gone from 3.25% at the beginning of the year to 7% now. Businesses have been increasing prices of their goods and services to offset their increased expenses (including interest expenses). If they are successful in raising their prices, the consumer is hurt.

• Jobs tied to interest sensitive sectors of the economy may be impacted. We have already seen that in the housing sector. Mortgage activity has dropped off and some mortgage firms have reduced hours for employees or eliminated positions. Employees who have bonuses or commissions tied to home sales have seen those payments decline or disappear. This reduces their ability to spend.

A few reminders about recessions:

• It is important to understand that recessions, when they occur, are unique to each person and business. Some people and businesses may feel that they are already experiencing recessionary conditions and others see no signs of a recession in front of them.

• The key for surviving a recession, whenever it occurs, is to prepare in advance. I use the term an “economic disaster recovery plan.” At the point in time when you or your business begin to see conditions changing, then you are able to remain objective and execute your disaster recovery plan.

• A recession is historically a cleansing process for an economy that has built up excesses. Unfortunately, that means some people lose jobs and some businesses close. It also creates opportunities. By planning ahead and being ready, you help ensure that you will be able to manage a recession and look for the opportunities.

As it stands now, the economy is still growing but slowing. It is critical for everyone to focus on what is actually happening with your business and not on what is being said in the media. The worst risk to the economy is if people start behaving like we are in a recession and create a self-fulfilling prophecy.

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