After almost a yearlong battle, inflation is finally showing signs of cooling as signaled in this week's Consumer Price Index report. The stock market rallied in response, with investors hopeful that the Federal Reserve might finally back down on aggressive interest rate hikes at next month's meeting.
While that seems like good news for the economy, it's important to note that prices are still going up -- they're just not increasing at the same rate we saw throughout the spring and summer. This may indicate that both the Fed's rate hikes and the overall improvement in the supply chain are starting to bring down the inflation rate. But it's too soon to know if inflation will indeed start to go down.
There remain widespread concerns over a recession, though experts predict it will be milder than many originally thought. But as prices remain high and interest rates soar higher, whether we're facing an official recession feels like a game of semantics. And, with more layoffs in the news, it's clear that everyday Americans are struggling.
Here's what to expect during periods of decline, what to know about layoffs and interest rates and a few tips on how to save, invest and make smart money moves in uncertain times.
Read more: It's Been a Wild Ride for the Stock Market. What's Next?
What happens during a recession?
It's always helpful to go back and review recession outcomes so that we can manage our expectations. While every recession varies in terms of length, severity and consequences, we tend to see more layoffs and an uptick in unemployment during economic downturns. Accessing the market for credit may also become harder and banks could be slower to lend because they're worried about default rates.
Read more: The Economy Is Scary. Here's What History Tells Us
As the Federal Reserve continues to raise rates to try to clamp down on inflation, we'll see an even greater increase in borrowing costs -- for mortgages, car loans and business loans, for example. So, even if you qualify for a loan or credit card, the interest rate will be higher than it was in the prior year, making it harder for households to borrow or pay off debt. We're already seeing this in the housing market, where the average rate on a 30-year fixed mortgage is around 7%, with some buyers seeing rates well above 7% -- the highest level since 2009.
During recessions, as rates go up and inflation cools, prices on goods and services fall and our personal savings rates could increase, but that all depends on the labor market and wages. We may also see an uptick in entrepreneurship, as we saw in 2009 with the Great Recession, as the newly unemployed often seek ways to turn a small business idea into reality.
Should we expect more layoffs?
With layoffs happening at big-name companies like Meta and Twitter, job security is top of mind for many. Right now the official Bureau of Labor Statistics unemployment rate sits at 3.7%, which is considered low. The Federal Reserve anticipates the unemployment rate rising to 4.4% by the end of 2023, which indicates more layoffs are on the horizon.
But the official unemployment rate doesn't show the full picture, as CNET editor Laura Michelle Davis noted in a recent story unpacking the unemployment statistics. "Individuals who've given up looking for work aren't even counted as unemployed, while part-time employees or freelancers who might find only one hour of work per week -- financially unsustainable by any standard -- are treated as employed," Davis wrote. According to the Ludwig Institute for Shared Economic Prosperity, the true percentage of Americans battling unemployment or underemployment is closer to 22.3%.
During the Great Recession, when unemployment peaked at 10% per the BLS measurement, it took an average of eight to nine months for those out of work to secure a new job. So now could be the time to review your emergency fund if you think there's a shortfall. If you won't be able to cover a minimum of six to nine months' worth of expenses, which is hard for most people, see if you can accelerate savings by cutting back on spending or generating extra money. It's also a good time to make sure your resume is up to date and to establish contact with influential individuals in your professional and personal networks. If you are laid off, make sure to apply for unemployment benefits right away and secure your health insurance.
If you're self-employed and worried about a possible downturn in your industry or a loss of clients, explore new revenue streams. Aim to bulk up your cash reserves as well. Again, if previous recessions taught us anything, it's that having cash unlocks choices and leads to more control in a challenging time.
Will interest rates on loans and debts keep increasing?
Although this week's CPI data reports some good news, prices are still climbing... which means another rate hike is coming in December, though it might not be as drastic as the last several ones. You should prepare for interest rates on mortgages, credit cards and loans to keep going up for a while, making your monthly payments more expensive.
Paying down your debts now, if you can, is the best way to avoid interest accumulating. If you can't pay off your debts completely, ask your lenders and card issuers about low-interest credit options or see if you can refinance or consolidate debts to a single fixed-rate loan.
In past recessions, some financial institutions were hesitant to lend as often as they did in "normal" times. This can be troubling if your business relies on credit to expand, or if you need a mortgage to buy a house. It's time to pay close attention to your credit score, which is a huge factor in a bank's decision. The higher your score, the better your chances of qualifying and getting the best rates.
Should I stop investing in my 401(k)?
The stock market has been spiraling for most of 2022, though it experienced an uptick this week in light of the better-than-expected inflation report.
Regardless of what happens next week, continue investing if you can afford it. Avoid panicking and cashing out just because you can't stomach the volatility or watch the down arrows during a bear market.
My advice is to stop knee-jerk reactions. This may be a good time to review your investments to be sure that you're well-diversified. If you suddenly experience a change in your appetite for risk for whatever reason, talk it through with a financial expert to determine if your portfolio needs adjusting. Some online robo-advisor platforms offer client services and can provide guidance.
Historically, it pays to stick with the market. Investors who cashed out their 401(k)s in the Great Recession missed out on a rebound.
The one caveat is if you desperately need the money you have in the stock market to pay for an emergency expense like a medical bill, and there's no other way to afford it. In that case, you may want to look into 401(k) loan options. If you decide to borrow against your retirement account, commit to paying it back as soon as possible.
Should I wait to buy a home?
Despite a drop in rates this week, mortgage rates have tiptoed over the 7% rate threshold. And with house prices still high, buying a home right now could be more expensive than renting. A report from the John Burns Real Estate Consulting firm looked at the cost to own versus renting across the US in April and found that owning cost $839 a month more than renting. That's nearly $200 greater than at any point since the year 2000.
Fixed rates on 30-year mortgages have essentially doubled since last spring, which has helped slow down offers and cool housing prices -- but competition among buyers is stiff due to historically low inventory. All-cash offers and bidding wars continue in plenty of markets. If you've been shopping for a home in recent months or the past year to no avail, you may feel exhausted and defeated.
Don't be hard on yourself. You're not doing anything wrong if you have yet to offer the top bid. While it's true that a fixed-rate mortgage can offer you more predictability and budget stability, as long as inflation continues to outpace wages, there could be some bright sides to renting right now. For one, you're not buying a home in a bubble market that some economists are saying is soon to burst. If you have to unload the home in a year or two -- during a possible recession -- you may risk selling at a loss.
Secondly, renting allows you to hold onto the cash you would have spent on a down payment and closing costs, and will help you stay more liquid during a time of great uncertainty. This allows you to pivot more quickly and secure your finances in a downturn. Remember: Cash is power.
Read more: With the Housing Market Facing an 'Especially Cold Winter,' Can Homebuyers Gain the Upper Hand?
My final note is that it's important to remember that recessions are a normal part of the economic cycle. Long-term financial plans will always experience some declining periods. Since World War II, the US has had about a dozen recessions and they typically end after a year or sooner. By contrast (and to give you some better news), periods of expansion and growth are more frequent and longer lasting.