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4 Reasons Why the Economy Appears to Unravel

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The current state of the U.S. economy is undeniably peculiar. Job opportunities abound, inflation is soaring at rates unseen since the 1980s, the real estate market is booming, and consumers are spending extravagantly. Yet, the specter of a recession from 2007 seems to loom over discussions. What’s really happening?

Signal 1: The Fed Raises Interest Rates Inflation has spiraled out of control, prompting the Federal Reserve to combat rising prices by increasing interest rates, intentionally slowing down the economy. However, the Federal Reserve’s timing in raising rates has been questionable. Despite mounting concerns about inflation throughout 2021, the central bank only began raising rates in March 2022. Last week, the Fed implemented the largest rate hike in 22 years.

Fed Chairman Jerome Powell stated the intention to continue these half-percentage-point increases until satisfied that inflation is under control, followed by quarter-point increases for a period. While the Fed believes it can raise interest rates without plunging the economy into a recession, past experiences make the achievement of a “soft landing” elusive.

Signal 2: Stock Market in Sell-Off Mode Extreme fear permeates Wall Street this year, with CNN Business Fear & Greed index at a meager 6 out of 100. Since reaching historic highs in early January, the stock market has lost nearly a fifth of its value, with the Nasdaq already in bear market territory. Concerns about rising interest rates eroding corporate profits have triggered a mass exodus of investors.

This not only affects retirement plans but also impacts those reliant on the stock market for income, including day traders accustomed to the market’s upward trajectory. Additionally, the plummeting consumer sentiment in May to its lowest level in 11 years spells bad news for an economy heavily dependent on consumer spending.

Signal 3: Bond Market Fluctuations Traditionally, when investors lose enthusiasm for stocks, they turn to bonds. Not this time. U.S. Treasury bonds, typically considered safe, are being sold. As bond prices fall, yields rise‚ÄĒ10-year Treasury yields surpassed 3% this month for the first time since 2018. This shift often occurs when the Fed raises rates, making bonds more attractive to investors with higher interest payments.

The sale of bonds has been exacerbated by the Federal Reserve’s decision to divest its massive portfolio of Treasury bonds purchased since the pandemic. As bonds are sold, and concerns of an economic recession heighten, the difference between short-term and long-term bond yields narrows‚ÄĒa phenomenon known as yield curve inversion, historically preceding recessions.

Signal 4: Global Chaos None of these economic shifts occur in isolation. Russia’s ongoing deadly invasion of Ukraine has disrupted supply chains and skyrocketed energy prices. China’s lockdown of major cities due to persistently high COVID-19 cases adds to global uncertainties. Worldwide labor shortages have driven up wages and impeded the normal flow of goods.

The actions abroad could reverberate in the U.S., adversely affecting its economy at a critical juncture.

What to Do While a recession may be on the horizon, panicking is not the solution. Advisors suggest taking proactive steps to insulate finances:

  1. Secure a New Job Now: In a market with ultra-low unemployment and numerous job offers, act swiftly as this scenario may change rapidly in a recession.
  2. Capitalizing on Housing Boom: If selling your house is under consideration, now might be the opportune moment. While U.S. home prices have surged nearly 20% YoY, rising mortgage rates will eventually dampen demand.
  3. Maintain Cash Reserves: Having liquid assets‚ÄĒcash, money market funds, etc.‚ÄĒis prudent for covering urgent needs or unforeseen emergencies.

In conclusion, while a recession may be imminent, the severity remains uncertain. Planning for the worst, maintaining discipline, and avoiding emotional reactions are essential strategies. As certified financial planner Mari Adam advises, “Stay invested, be disciplined.” History shows that market sentiments, even of experts, often prove inaccurate. The best way to achieve long-term goals is to remain invested and stick to your allocation strategy. Contributions by Allison Morrow and Jeanne Sahadi from CNN Business contributed to this report.

 

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