Agricultural Trends

May 13, 2022

Economic Storm Clouds on the Horizon

By Dr. David M. Kohl

If two years of the pandemic and the Russo-Ukrainian War were not enough to manage, leading economic indicators are now showing signals of a possible economic downturn. These signals are in the early stages but need close attention.

Inverted yield curve

An inverted yield curve is an early warning sign for an economic downturn. Simply stated, an inverted yield curve is when short-term interest rates are higher than longer term interest rates. The yield curve has been inverted in every recession since 1959. On a cautionary note, an inverted yield curve has predicted recessions that did not occur, which were typically the result of preemptive Federal Reserve strategy to avert the downturn. As the Federal Reserve increases interest rates and reduces accommodative action, it will be interesting to watch both short- and long-term interest rates. It usually requires a few months to verify the validity of the inversion.

Consumer confidence

During the 128-month economic expansion prior to the pandemic, the Index of Consumer Sentiment, published by the University of Michigan, was strong with readings above 90 for nearly 95% of the time. Fast-forward to today and the index has been in the low 60s and high 50s in recent months. Seventy percent of the U.S. economy is driven by services and consumption. The price of airline tickets and hotel rooms are skyrocketing with pent up demand while consumers spend their saved stimulus funds. It will be interesting to observe if this spending is sustainable. The Russo-Ukrainian War, high fuel prices and inflation at a level not observed for decades are all leading the consumer to possibly tap the brakes. Demand destruction caused by high prices will need to be observed over the next few months to determine if consumer confidence will continue to diminish later this spring and summer.

Other factors

Until recently, real estate and stock market values have been quite resilient during the aberrations of inflation and geopolitical turmoil. This has created the wealth effect, which has offset the two aforementioned factors. The wealth effect finds that as stock values and the value of real estate increases, the consumer spends anywhere from $0.04 to $0.09 more on every dollar. We are experiencing the wealth effect as a result of the growth in paper wealth. One danger sign for this category is when the growth of paper wealth exceeds earnings, which has been occurring in recent years. The question becomes, will higher interest rates suppress corporate earnings, alter investor psychology and strategy, tamper wealth gains and lead to a recession?

The economic storm clouds are brewing in both the business and economic landscape. Only time will tell what factors could create an economic storm that might lead to a category 3 to a category 5 downturn analogous to a hurricane.

Dr. Kohl is Professor Emeritus of Agricultural Finance and Small Business Management and Entrepreneurship in the Department of Agricultural and Applied Economics at Virginia Polytechnic Institute and State University. Dr. Kohl has traveled over 10 million miles throughout his professional career and has conducted more than 7,000 workshops and seminars for agricultural groups such as bankers, Farm Credit, FSA and regulators, as well as producer and agribusiness groups. He has published five books and over 2,500 articles on financial and business-related topics in journals, extension and other popular publications.