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Economic Outlook: Recession watch: U.S. economy is on shaky ground

Has the U.S. economy already toppled into a recession? Probably not, but it’s headed toward the danger zone.

The economy entered the new year with fading momentum. Rising interest rates orchestrated by the Federal Reserve to tackle high inflation have also delivered a big hit to growth.

Start with consumer spending, the main engine of the economy. It fell in the final two months of 2022.

Businesses aren’t about to come to the rescue, either.

Construction companies were the first to pull back last year after rising mortgage rates choked off home sales. More recently, manufacturers have retreated in response to slower sales.

Industrial production declined in both November and December and executives have signaled they will proceed with caution early in the new year.

The government is also not going to lend a helping hand like it did during the first few years of the pandemic.

Republicans who’ve taken control of the House are unlikely to support major fiscal stimulus if the economy falters. They blame a huge increase in government spending early in the Biden administration for contributing to high inflation — a point even some prominent Democratic economists don’t dispute.

All of that put together suggests to some economists that a downturn might be underway or is all but certain to take place quite soon.

“The economy was on the precipice of a recession, and may already have fallen off the ledge,” said Paul Ashworth, chief North American economist at Capital Economics.

The news is not all dire, however.

Take the labor market. The number of new filings for unemployment benefits fell to a four-month low of 190,000 in mid-January, keeping it near the lowest level since the 1960s.

The unemployment rate also slid to 3.5% in December to match the lowest level in more than 50 years.

Simply put, as long as most people are working, they are likely to keep spending just enough to keep business sales steady and discourage companies from laying off lots of workers. If so, the economy might avoid a recession altogether.

What’s more, the inflation balloon is quickly losing air.

The rate of inflation slowed to 5% in December from 5.5% in the prior month, based on the Fed’s preferred PCE price index published Friday. It had peaked at a 40-year high of 7% last summer, well above the central bank’s 2% goal.

Slowing inflation and a strong labor market, in turn, have given Americans a bit more optimism. Consumer sentiment rose in January for the second month in a row and Americans are increasingly convinced that inflation is easing.

If inflation keeps slowing, the Fed might stop raising interest rates soon. The bank is expected to raise rates again next week, but more and more Wall Street

investors bet it could be the last one this year. Some even think the Fed will cut rates later in 2023.

See: Fed set to deliver quarter-point rate hike along with ‘one last hawkish sting in the tail’

The big question is, has the die already been cast? Rising interest rates take time to slow an economy and it’s possible the worst is yet to come.

The Fed might also not be done raising rates.

One of its chief worries is a surge in wages tied to the strong labor market. Senior Fed officials want wage growth to slow further, an outcome that probably means some more layoffs and higher unemployment.

“For now, it still appears that the probability of a recession remains high,” said Jim Baird, chief investment office at Plante Moran Financial Advisors. “It’s not as much a question of ‘if’, but ‘when,’ ‘how severe,’ and ‘how long.’ ” 

Stay tuned. MarketWatch plans to check in regularly with readers to assess the broader health of the economy.

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