[Financial Planning for the 100-Year Life] Will the US Economy Enter a Recession?

High Probability of US Recession in Early Next Year
Middle-Class Real Income Declines... US Consumption Contracts
Be Cautious with Aggressive US Stock Investments

In August, key economic indicators such as employment came out worse than expected, leading to forecasts that the U.S. economy may enter a recession. The probability of a recession appears high in the first half of next year.

According to the National Bureau of Economic Research (NBER), the U.S. economy has been in an expansion phase for 51 months from its low point in April 2020 through July of this year. From December 1900 to April 2020, the U.S. economy experienced 23 business cycles, with an average expansion period of 48 months.

However, signs of economic slowdown are emerging. These signs are particularly evident in employment statistics. Long-term data since 1945 show that when the unemployment rate (12-month moving average) rises, the U.S. economy typically enters a recession about two months later on average. The 12-month moving average unemployment rate rose from a low of 3.56% in June 2023 to 3.87% in June this year (4.3% for June alone). According to historical data, a recession should have already occurred. Federal Reserve Chair Jerome Powell stated that this phenomenon is not an economic law but a statistical regularity, meaning that a rise in unemployment does not necessarily indicate a recession.

Is this time different? The answer depends on consumption, which accounts for 69% of the U.S. Gross Domestic Product (GDP). When examining the consumption cycle, it is already rapidly slowing down. According to my estimates, consumption has fallen below the long-term trend line this year. The reason for the slowdown in consumption growth lies primarily in the low savings rate of U.S. households. The savings rate from January to June this year was 3.6%, lower than the 2000?2019 average of 5.2%. (The 2020?2023 average was 8.6%, which was very high due to government financial support to households during the COVID-19 recovery.) This is the lowest level since 2.5% in 2007, the year before the financial crisis.

Low real income of households is also a factor limiting consumption growth. Since April last year, real income per capita has stagnated in the low $50,000 range. In particular, the real income of median households has declined for four consecutive years since peaking in 2019. Additionally, rising interest rates have increased households’ interest burdens. The share of interest payments in disposable income rose from 1.5% in 2022 (the 2010?2023 average was 1.9%) to 2.5% in June 2026. In the past, rising stock prices improved consumer sentiment. However, despite stock prices rising through July this year, consumer sentiment has weakened, indicating that U.S. households have less capacity to spend.

When consumption contracts, corporate sales and profits decline, leading companies to reduce employment. U.S. employment is flexible. When consumption sharply contracted due to COVID-19 in March?April 2020, nonfarm payrolls dropped by 21.89 million jobs in just two months. The unemployment rate surged from 3.5% to 14.7%. This time, the impact will not be as severe. However, if consumption shrinks, unemployment will rise, which in turn will further reduce consumption. Considering this, there is a high probability that the U.S. economy will experience two consecutive quarters of negative growth and enter a recession in the first half of next year.

The Federal Reserve is expected to begin cutting interest rates starting in September. If a recession occurs, the pace and magnitude of rate cuts will accelerate. Applying the Taylor rule, I estimate the appropriate federal funds rate to be 4.2% in the third quarter of this year and to fall to 1.6% in the first half of next year.

Last weekend, the yield on 10-year Treasury bonds fell to 3.79%. The average 10-year Treasury yield from 2000 to 2023 was 3.24%, which is 1.37 percentage points higher than the federal funds rate (1.88%). The 10-year Treasury yield reflects expectations that the federal funds rate will drop to about 2.4%. When unemployment rises and the benchmark interest rate falls, both the stock index and the dollar index also decline. This suggests that it is not the time to concentrate investments in U.S. stocks.

Kim Young-ik, Adjunct Professor, Graduate School of Economics, Sogang University