Why a Recession Looks Inevitable — and Why It Might Not Be
July 1, 2022 |
The C2FO Team
The odds of a recession are high. Here’s how you can prepare.
Is the world economy headed for a recession in the coming months? A growing number of decision-makers believe that a period of negative growth is on its way.
Almost 8 in 10 CEOs believe a recession has either started in their primary region of operation or will start sometime within the next 12 to 18 months, and 15% say they’re already in a recession, the Conference Board reported.
A recent Wall Street Journal survey of economists found there’s a 44% chance of a US recession within the next 12 months. Historically, when the survey’s consensus is that size, the economy tends to end up in a recession.
The euro area could enter a recession by the fourth quarter of this year, Barclays said.
A recession might be a good thing for some regions: A Citigroup economist noted that slowdowns in other countries could benefit Indian companies by making commodities more affordable.
But while the risk of recession is real, there’s also an argument that we might still be able to avoid it.
Why so many people think a recession is unavoidable
It all comes back to inflation. It’s (a) real, (b) persistent and (c) frustrating.
For months now, most regions have been coping with inflationary pressures that haven’t been seen in decades, driven by larger forces like supply chain shortages, high demand and the Russian invasion of Ukraine.
To push back against runaway prices, central banks around the world have been raising interest rates or announcing plans to do so. Higher interest rates make it more expensive to borrow money to buy assets or fund business expansions. Demand cools, and in theory, price increases should ease or even reverse.
Unfortunately, rate hikes aren’t a precise tool. It’s difficult to know how much to raise rates (or when to do so) so that policymakers achieve their goal of lower inflation without causing excessive job losses and business slowdowns.
“Engineering a soft landing is really, really hard,” said Chris Atkins, C2FO’s president of capital finance and capital markets.
Given current conditions, he said, the chances of a recession are fairly high. It might be a “pill that we have to swallow” in order to halt runaway inflation, which would cause hardship not seen since the 1970s and early 1980s.
A better question to ask might be how long or short a possible recession would be. Policymakers need to keep an eye on wage growth, job losses and similar metrics to make sure that interest rate hikes don’t go too far and cause greater damage.
Why a recession isn’t guaranteed
The European Central Bank (ECB), which is planning to raise interest rates in July, says it’s watching for signs of recession but argues that it’s not inevitable.
“We have markedly revised down our forecasts for growth in the next two years,” ECB President Christine Lagarde said. “But we are still expecting positive growth rates due to the domestic buffers against the loss of growth momentum.”
The International Monetary Fund forecasts that, while the US economy will slow down this year and in 2023, it should be able to avoid recession, though there are still risks of more negative shocks like the Russia-Ukraine war or the persistence of headwinds like high inflation.
Federal Reserve Chairman Jerome Powell told Congress that a recession is a possibility, “but not our intended outcome.” He argued that, overall, the US is in a good position to adapt to higher rates because the overall economy is strong and both businesses and consumers have sufficient financial resources.
But there’s a risk, Atkins said. Going from prime rates of 3.25% to potentially 6% or higher by the end of 2022 would mean almost doubling interest costs for borrowers.
If a borrower is on the line – i.e. they just barely qualify — banks will restrict them and cause them to pay down their lines, which could have a rapid and adverse effect on business spending and employment, for example.
Deloitte Canada puts that country’s chances of avoiding recession at 60%, noting that households have strong savings, unemployment is low and the Bank of Canada is taking action to fight inflation — which are all reasons for confidence.
But there’s one factor that is hard for forecasters to account for: fear. If enough people and businesses believe a recession will definitely happen, they’ll change their spending and help push the economy into recession.
“If a recession mindset really takes hold, it can actually cause the thing that everybody fears,” Craig Alexander, Deloitte Canada’s chief economist, told the Toronto Star.
What businesses can do now to be ready
Whether a recession does or doesn’t materialize, there are things you can do now to prepare. These steps can benefit you even if the economy never stops growing.
Build a cash reserve. If demand drops off and your customers disappear, you’ll need the funds to continue making payroll and keeping the lights on. One rule of thumb is to keep three to six months’ worth of operating expenses on hand, though business advisors like SCORE argue that you could need more or less depending on your company’s circumstances. A brand-new business, for example, might require more than an established company in a relatively stable niche.
Accelerate your receivables. Now may be the time to offer a discount for faster payment. C2FO’s platform makes it possible for businesses to receive payment 30, 60 or even 90 days ahead of schedule in exchange for a small discount on an invoice.
Be careful about getting locked in to contracts or commitments that give you no way out if economic conditions worsen. Get as flexible as practicable to ensure you can adapt to a changing environment.
Audit your spending, but don’t eliminate useful programs or services, especially initiatives that help you generate revenue.
Have a Plan B … and a C and a D. If your business needed cash, where would you go first? And where would you go if your first choice wasn’t an option? Some advisors recommend establishing a relationship with a funder while your finances are still in good order and before lending standards tighten, which tends to happen during a recession. Here are some helpful tips to improve your eligibility for working capital financing.
Need help weighing your options? C2FO was built to help businesses like yours secure the working capital they need even during challenging times.