Are inflation and interest rates leading towards a recession?
Rising inflation and interest rates may have you concerned about the state of the financial markets and economy. High inflation and interest rates can lead to a period of volatility in the financial markets. Are we facing a recession or is this just another cycle that will pass?
Inflation Finally Deflating?
Inflation has been at its highest level in decades, and it is eating into consumers' purchasing power. But it may be finally slowing down. The U.S. Bureau of Labor Statistics (BLS) reported that the Consumer Price Index (CPI) increased 4.9% for the 12 months ending April 2023, the smallest increase since the period ending April 2021. The energy index decreased 5.1 percent for the 12 months ending April, and the food index increased 7.7 percent over the last year. This inflation rates are still high and leading to concerns about a slowdown in economic growth. However, it is important to note that inflation is not an isolated problem. It is being driven by a variety of factors, including supply chain disruptions and labor shortages. It is hard to say how long inflation will continue to be a problem. However, the Federal Reserve is taking steps to bringing inflation under control.
Rising Interest Rates
The Federal Reserve (Fed) has attempted to combat the historic inflation rates with aggressive back-to-back interest rate hikes. The Fed recently held another meeting and raised the interest rates yet again. This 25 basis point rate hike brings the fund rate up to 5.25%.
The Fed continues to try to combat inflation and unemployment with the main tool they have at their disposal – interest rates. They continue to use it in an attempt “to achieve maximum employment and inflation at the rate of 2 percent over the longer run.” Fed Chair Jerome Powell said the economy will continue to grow at a moderate pace this year. But the forecast from the staff is that we will have a mild recession this year.
“The FOMC struck an appropriate balance between taming inflation while avoiding exacerbating stress in the banking system,” Fed Chair Jerome Powell said. “Assuming banking issues subside, additional rate hikes may be needed, but it’s time for a pause to allow the full effects of tightening to work its way through the economy.”
Higher interest rates can be a sign of a healthy economy. However, when the interest rates too high, it becomes more expensive for businesses to borrow money which can slow down growth and hiring. And this could cause a recession - a period of economic decline.
There is some general concern about the combination of high interest rates and inflation causing a recession. There is the potential for higher unemployment, a decline in the housing market, and decline in the markets. Fed Chair Powell’s outlook is we are likely to be able to avoid a mild recession this year but only time will tell.
It is important to remember that the financial markets are cyclical. They go up and down over time. The current period of volatility is likely to be temporary, and the markets will eventually recover. However, it is important to be prepared for volatility and to have a diversified portfolio. This will help to protect your investments during periods of market turmoil.