The Gross Domestic Product (GDP) of the United States declined at an annual rate of 0.3% in the first quarter of 2025. Coming at a time when people were already anxious about the impact of new tariffs and federal budget cuts, this drop in economic activity sparked serious concerns about where the economy is headed.

Any decline in GDP is unwelcome news. However, things would need to worsen significantly for this to qualify as a recession. Still, it might be wise to start preparing.

Certainly, any decline in GDP is not good news. However, things would have to get much worse for this to be considered a recession. Still, it wouldn’t hurt to take some steps to prepare.

Economic contractions are rare but not always recessions

Economic expansions occur when the economy grows, and contractions happen when it shrinks. These changes are measured after adjusting for inflation. In other words, the economy must grow faster than the inflation rate for it to count as an expansion. This inflation-adjusted growth rate is often referred to as the “real” rate.

Declines in economic activity have been rare since the end of the Great Recession

News that the economy shrank at a real annual rate of 0.3% raised concerns about a possible recession. That reaction stems, in part, from the rarity of contractions in recent years. Since emerging from the Great Recession in mid-2009, the U.S. economy has experienced only seven quarters of decline out of 63 — that’s just 11% of the time.

The rarity makes the latest decline unsettling, but one bad quarter does not constitute a recession. In fact, contrary to popular belief, even two consecutive quarters of economic contraction do not automatically meet the definition.

Defining a recession

The National Bureau of Economic Research (NBER) defines a recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.” That means three key conditions must be met:

• The decline must be meaningful.
• It must be widespread across different sectors.
• It must be sustained and not just a routine fluctuation from one month or quarter to the next.

The NBER intentionally keeps the definition somewhat subjective because, in some cases, one factor may outweigh the others. For instance, when the COVID-19 pandemic hit the U.S. in early 2020, the economy contracted for just two months, but by over 30%. That brief but dramatic downturn was enough to be considered a recession.

As for now, the 0.3% decline in the first quarter of 2025 is neither deep nor prolonged enough to count as a recession, at least not yet. Whether it becomes one depends on what comes next.

Mixed signals create uncertainty

Further complicating the picture is a stream of conflicting data. While GDP dipped, the decline was mild. April 2025 saw employment gains, though growth slowed compared to the previous month. In addition, earlier job growth estimates for February and March were revised sharply downward.

Consumers, who drive roughly two-thirds of U.S. economic growth, are also sending mixed messages. Consumer spending has risen over the past two months, yet consumer confidence has dropped for four months in a row. One explanation for this disconnect is that much of the recent increase in spending came from motor vehicle purchases. Concerned about potential tariffs, some consumers may be rushing to buy now, possibly leading to slower sales later and increasing recession risk.

So far, the economy is not in a recession. But there are enough warning signs to justify caution.

What happens in a recession and how to respond

To understand why people worry about recessions, it helps to consider some of the common consequences:

Unemployment typically rises

• What happens: As business slows, companies often cut jobs. Hiring is typically slow to resume even after the recession ends. The Great Recession began in January 2008 and ended mid-2009, but net job losses continued until February 2010. More than 8 million jobs were lost, and national employment did not return to pre-recession levels until May 2014. Many Americans faced prolonged joblessness.
• What to do: Reduce expenses and build emergency savings if possible. Evaluate how secure your job is, and consider whether you can improve your skills or transition to a more stable employer.

Credit becomes harder to get

• What happens: Job losses often lead to missed debt payments and lower credit scores. At the same time, lenders grow more cautious and tighten lending standards. The result is that fewer people qualify for credit.
• What to do: Strengthen your credit score now. Pay down debt, avoid taking on new credit unless necessary, and create a budget that fits your current income. Get a complete view of your credit score for free.

The stock market gets volatile

• What happens: Economic troubles often hurt the stock market, but not always in obvious ways. Investors tend to act in anticipation of events. That means markets may start falling before a recession is confirmed and start recovering before it ends.
• What to do: Avoid drastic reactions. By the time a recession is officially recognized, the worst may already be over for markets. Instead, rebalance your portfolio if needed and stay focused on your long-term investment goals.

Practical steps for uncertain times

Staying prepared is more helpful than trying to predict the future. A single quarter of decline does not mean a recession has begun, but it is a reminder to take stock of your finances. Focus on steady, practical actions that can strengthen your position. Build up your savings, keep your credit in good shape, and avoid taking on new risks without a clear plan. These habits can help you stay steady, even if the economy becomes more difficult in the months ahead.

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Investors enjoyed significant gains last year as falling interest rates and a resilient economy drove the stock market to new record highs, fueling a bull market. In a bull market, when stock prices steadily rise, this upward momentum often attracts more investors eager to capitalize on the trend. However, bull markets don’t last forever.

Will 2025 mark the end of this streak? Predicting when investor confidence will wane is impossible, but cautious investors should note that some of the factors fueling the stock market’s growth in recent years could now start to act as headwinds.

Bull market yields best back-to-back years in decades

The S&P 500 finished 2024 up 23.31%. On the heels of a 24.23% gain in 2023, that gave the stock market back-to-back annual gains of more than 20%. How unusual is that? The last time the S&P 500 accomplished that feat was in 1997 – 1998. Here are some of the things that have fueled the current bull market:

• The stock market was coming off a bad year in 2022 when the S&P 500 lost 19.44%. The resulting low prices gave stocks plenty of room to bounce back.
• Falling inflation and interest rates made stocks more attractive as long-term investments.
• Consumers have been willing to borrow heavily so they can continue spending. This has helped the economy grow for ten quarters in a row.

These factors have served the market well over the past two years. However, there are reasons to question whether that success can continue.

Stock prices are already high in the bull market

With strong increases in 2023 and 2024, the S&P 500 ended 2024 at a record monthly high. Still, just because the stock market has increased significantly doesn’t mean it’s overpriced. To put stock prices in perspective, stock analysts often look at them relative to company earnings.

Over the past two years, stock prices have risen by 53.19%. Reported earnings of S&P 500 stocks over that same time are up by 42.38%, and operating earnings are up by just 21.34%.

In other words, the prices people are paying for stocks have gone up faster than the ability of those companies to make money from their businesses. As a result, the price-to-earnings ratio of the S&P 500 has risen from 22.23 to 28.16 in the same period.

A high price-to-earnings ratio means that investors expect earnings to grow strongly in the future. If all goes well, the impact on the stock market will be muted because people have already priced the expectation of good news into those stocks. On the other hand, a high price-to-earnings ratio gives stocks farther to fall if there’s a setback.

Inflation and interest rates may create a headwind

One reason stocks rose faster than earnings last year is that inflation and interest rates both eased. Lower inflation and interest rates increase the value of future stock earnings. In theory, this should make those stocks worth more.

However, as 2024 closed, many people started to revise their view of inflation. For example, the Federal Reserve raised its estimates of where inflation will be over the next couple of years. Bond yields, which had been falling throughout the middle of the year, began to rise as investors thought about the inflationary impact of trade wars and a more restricted labor supply.

Stocks like low inflation and interest rates. For much of 2024, they had the wind at their back as those things fell. Now, investors are concerned that rising inflation and interest rates may become a headwind in the year ahead.

A significant portion of consumers are tapped out

Finally, another key driver of the bull market has been the willingness of consumers to take on debt to continue to spend. There are signs that this source of consumer demand may be petering out, at least for a significant segment of the population.

The dollar volume of defaults on credit card debt through the first 9 months of 2024 was 50% higher than in the same period a year earlier. It had reached its highest level since 2010, when the economy was still recovering from the Great Recession.

Certainly, plenty of consumers are ready and able to continue spending. However, a growing share of lower-income and lower-credit-score consumers struggle to pay their bills. Notably, consumer confidence plunged in December 2024, suggesting the spending spree may end.

Many factors impact the economy and the stock market, not all of which can be foreseen. However, it does seem that some of the forces that helped investors and consumers in 2024 may not be so favorable in 2025.

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With low unemployment and a soaring stock market, you might expect that Americans are getting themselves in good shape for retirement. Two recent surveys suggest that this is not the case. A study of current workers showed that while most middle-income earners save for retirement, they generally do not save enough. Retirement saving can be challenging, but it can be handled in small steps with the right habits.

50% of retirees did not save enough

An Employee Benefit Research Institute (EBRI) survey examined how Americans between 62 and 75 years find their financial health in retirement. Half the retirees surveyed said their savings weren’t enough to cover their needs. Only about a third said they’d saved the right amount, while 17% said they’d saved more than enough.

The issue of not saving enough may be even worse than these numbers suggest. That’s because 68% of retirees said they owed credit card debt, which shouldn’t be necessary if savings were enough to cover their living expenses. Given the high cost of credit card debt, why would these retirees carry it? They may also have saved too little for retirement.

What about the current workforce?

The Principal Group found that 77% of middle-income earners are saving for retirement. That’s more than three out of four, which sounds pretty good. However, not all these people save enough to cover their needs. The survey indicates that saving households put aside an average of 7.8% of income for retirement. This is well short of the Principal Group’s recommended target of 15%.

In a news release about the survey, a spokesperson for the Principal Group put an optimistic spin on this 7.8% savings rate. Teresa Hassara pointed out that if these workers also receive a typical employer match of 4% to 6% on their retirement contributions, it would put them “within range” of the recommended savings rate.

That’s a nice thought, but it doesn’t quite add up. First, not all employees participate in a retirement plan with an employer match. Plus, even if someone saving at a 7.8% rate received a 4% to 6% employer match, that would put their total savings at 11.8% to 13.8%.

This is significantly short of the 15% target. Projected over decades of retirement saving, being off by a few percent is like being off by a few degrees in the direction of space travel – it eventually leaves you hopelessly far from your desired destination.

The survey also found that 30% of respondents have compounded the under-saving problem by making early withdrawals from their retirement accounts.

People may think they will make up for those lost savings by putting more into the plan later on, but that often proves impossible because of a combination of factors:

• Tax penalties on early withdrawals
• Lost investment earnings while the money is out of your account
• Annual contribution limits on tax-deductible saving
• Plan limits on annual employer matches

There’s one more sobering thing about the Principal Group’s retirement survey. It was based on middle-income earners, which they defined as people earning between $50,000 and $99,999 a year. However, roughly 30% of Americans earn less than $50,000, so there are many Americans whose retirement savings are probably even worse off than those portrayed by this survey.

Tips for a better retirement plan

Saving money for retirement is hard, and there is no one magic solution. Instead, there are smaller, manageable steps you can take to get your retirement saving in better shape.

• Build your budget around a workable saving goal. People tend to save any money they have left over from their day-to-day expenses. Instead, you should start by budgeting enough savings to reach your retirement goals and fit the rest of your budget around that.
• Keep your credit healthy. From credit cards to car loans to mortgages, you will probably use credit throughout your adult life. Monitoring your credit and taking steps to build credit can help ensure you get lower interest rates. That will leave you more money for retirement savings.
• Avoid credit card debt. Credit card debt is much more expensive than most other forms of consumer debt. Carrying regular credit card balances creates an ongoing drain on your finances. That can hurt you both now and in retirement.
• Do not dip into savings early. As retirement balances grow, viewing them as a resource you can tap into as needed is tempting. However, dipping into retirement savings early can be hard to recover from.
• Do not coast after good investment years. A few good years make people think they’re far enough ahead on their savings goals to cut back on their plan contributions. Remember, year-to-year investment returns are erratic, so you need to keep any cushion you earn in reserve for the inevitable lean years.

The EBRI survey found that half of retirees regret not saving more for retirement. Try not to put yourself in the position of discovering that after it is too late to do anything about it.

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The typical American homebuyer is getting older, with recent housing market statistics showing that Americans delay home purchases until later in life. There are good reasons for this, but it is important to recognize how it complicates retirement planning. A decision to enter the housing market later should inform when people start saving for retirement and how much money they should plan on needing.

Housing affordability has taken a beating in recent years

In recent years, long-term demographic trends to purchase later in life have been exacerbated by immediate economic conditions, making it harder to afford a home. According to the S&P CoreLogic Case-Shiller US National Home Price Index, the average home price has increased for twelve calendar years. The index will likely extend that streak to thirteen straight years by the end of 2024.

Over the past ten years, the average home price has increased by 94.35%. Over half of this increase (a 53.54% rise) has happened in the past five years. In short, home prices have been getting more expensive at a dizzying pace. As if higher home prices are not challenging enough, the affordability of buying a home has been made worse by a sharp rise in mortgage rates.

Fall 2024 rates are still lower than their long-term historical average at 6.79%, but 30-year mortgage rates have more than doubled in the three years from late 2021 to late 2024. Over the ten years from the beginning of 2012 through the end of 2021, 30-year mortgage rates were mostly below 4%. Mortgage rates are now higher than consumers are used to.

Americans are buying homes later in life

How much do higher home prices and mortgage rates impact the housing market? As buying a home has become less affordable, more and more people have been forced to delay getting into the market. Recent statistics from the National Association of Realtors 2024 Profile of Home Buyers and Sellers reflect this delay:

• The median age of first-time buyers has risen to 38 years old. That’s up by 3 years from the previous annual report and the highest median age since the report was first compiled back in 1981.
• 26% of homebuyers paid for their purchases entirely in cash. This is the highest percentage in the report’s history. That high percentage of cash buyers reflects people’s aversion to paying today’s mortgage rates. Of course, amassing enough cash to buy a home without a loan takes much longer than qualifying for a mortgage.

It seems fast-rising home prices and higher mortgage rates have caused Americans to wait longer to buy a home on average.

Delayed homebuying impacts retirement saving

If Americans buy their first homes later in life, they should adjust how they save for retirement. Here are two ways retirement planning should adapt to the trend toward later home purchases:

1. People should begin saving for retirement earlier

Financial goals tend to fall along a timeline as people move through their careers. Buying a home has traditionally been a big priority for young adults, and once they’ve done that, they turn their attention to saving for retirement. The risk is that if people wait longer to buy a home, it also causes a delay when they start saving for retirement. This would be a mistake.

Retirement saving is a big job. It’s easiest if you spread it out over as many years as possible. Therefore, you shouldn’t wait until you’ve bought a home to start saving–especially if you’re putting off buying a home.

The years before you have mortgage payments may be an ideal time to start saving for retirement. It means people must balance two goals simultaneously–putting aside some money for retirement and saving for a down payment on a home.

The extra planning and discipline required to save for a down payment and retirement at the same time rather than one after the other can pay off in the long run. It can prevent you from delaying retirement indefinitely while you make up for the time you lost waiting to buy a home.

2. People should raise their retirement saving targets

People who buy houses later in life may have to save more for retirement. According to the Bureau of Labor Statistics, the average American spend on shelter peaks at $18,322 when people are in their late 30s and early 40s. It then starts to fall off as people approach retirement age. For people aged 65 and over, the average annual spending on shelter is $12,545–nearly a third lower than the peak.

A major reason these expenses usually fall later in life is that people pay off their mortgages. However, if people now wait longer to buy houses, that drop-off in expenses may not occur until later. This means people should plan on saving more for retirement to support higher annual housing expenses.

Without the near-term financial goal of buying a home, the risk is that young adults simply spend more. This would not only further delay their ability to own a home, but it could also jeopardize their ability to save enough for a comfortable retirement.

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A new study found that there are over 37 million Health Savings Accounts (HSAs) covering 61 million Americans. As of the end of last year, these accounts totaled over $123 billion. Notably, they are in widespread use across generations, from young adults to retirees.

Why have HSAs become so popular? One reason is that Americans love tax breaks, and HSAs have tax characteristics that are even better than IRAs and 401(k) plans. Beyond that, HSA versatility makes them useful across a range of age groups in a variety of ways.

What is a Health Savings Account?

HSAs are accounts designed to be used in conjunction with High-Deductible Health Plans (HDHPs). HDHPs are health insurance plans that offer lower premiums in exchange for higher deductibles. That means you pay less to have the plan month to month, but you are likely to pay more out-of-pocket when you have a medical expense.

HSAs are a way to accumulate tax-exempt savings, which can be used to pay medical expenses. They are designed to work in conjunction with HDHPs because of the higher out-of-pocket expenses those plans can expose people to. Money in an HSA can also go towards uncovered medical expenses.

Individuals can make tax-deductible contributions to these plans each year up to certain limits. For 2024, the limits are $4,150 for people with individual health insurance plans and $8,300 for those with family coverage.

The tax benefits go beyond deductible contributions. Earnings on investments within the plans are exempt from taxation. Money can be withdrawn from the plans at any time without being subject to taxes. The only restriction is that withdrawals have to be used for eligible healthcare expenses. Any money within an HSA that is not used within a given year can remain in the plan. That way, it can build towards future healthcare expenses.

HSAs were first authorized by a 2003 law. A recent study by Devenir Research found that by the end of last year, there were more than 37 million HSAs, covering an estimated 61.4 million people. These plans accumulated over $123 billion in assets.

HSAs are most popular with young adults

The age group that owns the most HSAs is people in their 30s. Thirty-somethings own more than 11 million of the 37 million total HSAs. As of the end of last year, these accounts were worth $22.76 billion.

HSAs are a good fit for young adults. People at that age are usually relatively healthy and have not yet reached their peak earning years. That makes a high-deductible, lower-cost health insurance plan a natural choice for many in this age group.

When someone with an HDHP has a healthcare expense, an HSA can help cover the cost of the higher deductible. Under normal circumstances, though, when those expenses don’t arise, they can put their money toward building savings in an HSA rather than toward paying higher premiums on a more comprehensive health insurance plan.

Older workers have built the most valuable HSAs

While young adults own the most HSAs, people around retirement age have the most money in those accounts. As of the end of 2023, people in their 60s had a total of just over $31 billion in their HSAs. Whereas the average balance across all HSAs is $3,296, people aged 65-69 had the largest average balance of any age group, at $6,483.

Up until age 65, people typically put more money into HSAs each year than they take out. This allows them to use the tax advantages of these accounts to save and invest for the long term. Over time, HSAs can become a good supplement to retirement savings.

People hang on to their HSAs well into retirement

While people typically start to draw down their HSA balances after age 65, many continue to hold onto the accounts well into retirement. These can help them meet healthcare expenses, which typically become a bigger share of spending in retirement.

According to consumer expenditure figures from the Bureau of Labor Statistics, 8% of spending for the average American goes to healthcare. However, for people over 65, that jumps to 13%.

For people who’ve built up an HSA balance throughout their career, gradually drawing down that balance in retirement can help them meet those higher healthcare expenses. Those expenses are why HSAs can be viewed as a long-term retirement saving tool in addition to a means of meeting short-term out-of-pocket costs.

The tax-free nature and flexibility of HSAs are attractive to all age groups, which helps explain their widespread popularity, as evident in the recent Devenir report.

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In theory, when interest rates rise, some consumers benefit while others suffer financially. However, a recent study found an imbalance. On average, rising interest rates have cost American consumers more than they’ve benefited.

Net interest earnings dropped as interest rates rise

Consumers earn interest on savings accounts and other interest-bearing products. In contrast, consumers pay interest on loans and credit card balances. When rates rise, consumers with more savings than debt should benefit from interest earnings. Consumers with more debt than savings should lose out because of increased interest payments.

A study by the Bureau of Economic Analysis found that this trade-off has worked against consumers overall as rates have risen over the past couple of years. Since the Fed started raising interest rates in early 2022, the total interest consumers pay on credit cards and loans rose by $420 billion. Meanwhile, the total interest they earn on savings has increased by just $280 billion. This interest earnings/payments disparity means consumers have lost out to the tune of $140 billion.

Why have rising interest rates worked against consumers?

There are a couple of market forces that have really tilted the playing field against consumers.

The Fed plays a prominent role in setting interest rates. However, when it comes to the rates offered to consumers, decisions by financial institutions have an important impact. Consumer choices have also contributed to the rising interest charges Americans are paying.

Credit card rates have risen faster than the Fed funds rate

An example is credit card rates. Credit card rates have risen more than the Fed funds rate over the past couple of years.

The Fed started raising rates late in the first quarter of 2022 and has since increased the Fed funds rate by 5.25%. The average rate charged on credit card balances has risen even more over the same time. It is now 6.58% higher than in the first quarter of 2022.

Credit card interest has risen more quickly than the Fed funds rate partly because lending money to consumers has become riskier. Late payment rates on credit card accounts have risen, and so have credit card balances.

Consumers carry more debt in credit card balances

Rising credit card balances also impact why consumers are paying more interest. Credit card interest rates are generally much higher than rates on other major forms of credit, such as car loans, mortgages, and personal loans. The more of your overall mix of debt you have in credit card balances, the more interest you’re likely to pay.

Over the last few years, credit card balances have been representing a rising percentage of total consumer debt. According to figures from the Federal Reserve Bank of New York, from the first quarter of 2021 through the end of last year, credit card debt as a percentage of total consumer debt rose from 5.26% to 6.45%.

With consumers now keeping more of debt in high-interest credit card balances, it’s no surprise Americans are paying more interest.

Deposit rates have not kept up

In addition to the interest consumers pay on their debt, there’s another side to the net interest equation. Consumers earn interest on their savings that may offset what they pay on their debts. Unfortunately, average rates on deposit accounts haven’t come close to keeping up with the average rates charged on consumer debt.

According to figures from the FDIC, since the Fed began raising interest rates in March 2021, the average interest rate offered on bank savings accounts has risen by just 0.43%. The average rate offered on 5-year CDs has risen by just 1.07%.

Those numbers are a far cry from the 5.25% increase in the Fed funds rate over the same period, let alone the 6.58% average increase in credit card rates.

How consumers can improve their net interest

To improve their net interest earnings, consumers need to take matters into their own hands. Here are four things you can do to improve your net interest:

1. Reduce debt balances. This is an especially expensive time to be carrying debt, so reducing debt can be especially rewarding right now.
2. Choose cheaper forms of debt. Only use credit cards for purchases you can pay off within a few months. If you need more time to pay, take out a loan with a lower interest rate—or consider delaying the purchase while you save up for it.
3. Shop for a better rate. Whether you’re looking for a credit card or a loan, there may be a better deal out there. Interest rates vary widely from one financial institution to another, so shopping around is well worth the time.
4. Work to improve your credit score. Loans and credit cards for poor credit customers charge much higher rates than those for people with good credit. Credit score improvements can affect your net interest earnings and thus help you build your net worth.

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Conflicting financial data can be a real head-scratcher. A mid-March 2024 report from the Federal Reserve showed that household net worth had reached an all-time high. The same report showed that household debt was also at a record high. This seems like a contradiction: Americans are wealthier than ever before yet owe more money than ever before.

The key to understanding that contradiction is recognizing that the data represents two types of people: net savers and net borrowers. Not only are these two groups in very different financial shape, but conditions recently have shifted decidedly in favor of one group over the other.

Wealth and borrowing are at record levels

One way to understand the apparent contradiction is to consider the various data points separately. Since the Great Recession ended in 2009, total U.S. household wealth has risen steadily to an all-time high of $156 trillion.

The chart shows that from the end of 2009 through the end of 2023, U.S. household net worth rose from $61.6 trillion to $156.2 trillion. It’s been a reasonably smooth ride, with just a few minor hiccups. The latest setback was in 2022, but household wealth shook off that setback and rose to new heights in 2023. This progress was thanks to strong asset growth.

From the end of 2009 through the end of 2023, the value of household assets grew from just under $76 trillion to $176.7 trillion. Net worth is calculated by subtracting liabilities from assets. Liabilities have grown even as assets have soared:

That period from the end of 2009 through the end of last year also showed persistent growth in household liabilities, which include various forms of debt. The pace of this growth has picked up over the past three years, bringing household debt to a record high of $20.5 trillion.

One explanation for why both assets and debt have grown so consistently over this period is that it was a great time for investment returns and a great time to borrow money. Different households embraced one or the other of those two experiences.

2010 to 2021 was a great time to borrow

First, let’s look at why so many households found borrowing money so attractive in the period following the Great Recession from mid-2009.

The above chart shows the Fed funds rate over the past 50 years. Since interest rates represent the cost of borrowing money, this chart can give you some idea of when borrowing has been expensive and when it’s been cheap. Over the past 50 years, the Fed funds rate has averaged 4.8%. However, in the aftermath of the Great Recession, it plunged to nearly zero—and stayed there until 2022.

While interest rates like credit card APRs and mortgages vary, the Fed funds rate gives a general idea of interest rate trends. What this chart shows is that from roughly 2010 through 2021, borrowing was unusually cheap. In effect, people were strongly encouraged to borrow during that period.

Stocks and real estate have provided strong asset returns

The flip side of low interest rates is that they are not very rewarding to people with traditional deposit products like savings accounts and CDs. These people earned very little return on their savings from 2010 to 2021, often not even enough to keep up with inflation.

On the other hand, though, the period following the Great Recession has been very good for real estate and stock market returns. Since the end of 2009, home prices nationally have more than doubled. The value of the S&P 500 has more than quadrupled.

Rates returned to normal last year, but borrowing kept on growing

In short, since the Great Recession, the U.S. has seen an extended period when borrowing was unusually cheap. That helps explain the record amount of debt American households amassed. The same period saw unusually strong growth in asset values, which explains why net worth has reached a record high. This isn’t so much a contraction as it is a view of two distinctly different types of financial behavior.

While many households have assets and liabilities, what matters is net worth, whether they have significantly more assets than liabilities or vice versa. While borrowing was unusually attractive for many years, that has now changed. The last few years saw the Fed funds rate rise to 5.33%, about half a percent above its 50-year average.

Most of the years since the Great Recession featured extremely low interest rates that encouraged record borrowing. Those same low rates punished savers in traditional deposit accounts, helping to push money into investments. This helped boost stock and real estate values.

Now that interest rates are higher, savers who invested in stocks and real estate still benefit from high asset values. For heavy borrowers, though, the script has flipped. The super-low interest rates are gone, leaving many in debt for extended periods.

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The end of February 2024 brought news of an upturn in the inflation rate. It also featured stories saying that the inflation rate was slowing. Both perspectives referenced the same data. How the data was interpreted is a reminder that understanding economic events can come down to an individual’s point of view.

Last week’s key inflation measure

On February 29, 2024, the Bureau of Economic Analysis released its report on Personal Income and Outlays for January 2024. This report is widely referenced for its information on consumer income and spending and data on trends in consumer prices.

Inflation has been a hot topic over the last few years, and the information on consumer prices is interesting. The BEA report includes information on the Personal Consumption Expenditures (PCE) price index. The PCE price index is significant because it is the measure of inflation that the Federal Reserve focuses on in making interest rate decisions.

The PCE price index reflects roughly the same inflation trends as the more widely-known Consumer Price Index (CPI). However, the PCE price index adjusts more rapidly to what consumers are actually buying. This is thought to reflect actual consumer behavior better. One way consumers deal with inflation is by substituting lower-priced goods for ones that have become more expensive.

The latest PCE price index data highlights that inflation had risen by 0.3% in January and by 2.4% over the past 12 months. Core inflation, which excludes the food and energy sectors, was up by 0.4% in January and by 2.8% over the past year. Core inflation is interesting because it measures how widely it has spread throughout the economy.

These numbers are not in dispute. Where opinions differ is in what they mean about the latest inflation trend.

Year-over-year inflation has slowed

One school of thought is that the numbers mean that inflation continues to slow down. This interpretation is based on the numbers for the past 12 months. The 2.4% inflation rate for the past 12 months was an improvement over the 2.6% rate for calendar year 2023. The 12-month number has fallen steadily, as illustrated by a series of recent reports on the PCE price index. Viewed this way, the trend is pretty clear: inflation is slowing. That’s good news for consumers and investors.

Recent inflation has sped up

However, not everybody sees it the same way. The 12-month numbers contain a lot of information that came out months ago. For example, the main reason the 12-month change in the PCE price index was lower through January 2024 than it was through December 2023 is that the January 2023 number dropped out of the 12-month period. The January 2024 number replaced it.

That’s significant because the January 2023 increase in the PCE price index was 0.6%, a big number for a single month. As the measurement period rolled forward, the January 2023 number was replaced by the January 2024 number. Since that more recent number was much lower (0.3%), the 12-month total went down. However, looking back 12 months doesn’t tell you what’s happened recently. Looking at the 1-month numbers for the PCE price index tells a different story. Viewed from this perspective, it seems as though inflation has been rising recently after falling to 0% in October and November 2023.

So is inflation up, or is inflation down?

The 12-month perspective may be too optimistic because it largely reflects old news rather than recent developments. However, 1-month numbers tend to jump around a lot, so it’s too soon to draw conclusions from the January 2024 number.

The bottom line is that inflation is roughly where it has been for the past several months. It has fallen but remained stubbornly above the Federal Reserve’s 2.0% target. The uptick in January is no reason for panic, but it is reason for caution. The February 2024 number, to be released toward the end of March 2024, will lend some perspective on whether that uptick was the beginning of a trend or just a one-month outlier.

What’s at stake

That need for caution may prompt the Fed to hold off cutting interest rates at its March 19-20 meeting. For consumers, that means the cost of borrowing is likely to remain high. This is a good time to rein in credit card balances and work on improving your credit score. Those moves can reduce the price you pay for high interest rates.

For investors, this is a good time to keep in mind that a lot of the stock market’s optimism is based on the belief that interest rates will come down. That may not happen as quickly as Wall Street expected a month or two ago.

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Disclaimer: The article and information provided here are for informational purposes only and are not intended as a substitute for professional advice.

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Sometimes, you must think laterally to understand the relationship between the stock market and the economy. On January 31, the Federal Reserve announced it was leaving interest rates unchanged, and the market reacted with a 1.5% drop. Hundreds of billions of dollars worth of stock values were wiped out in a single afternoon apparently because the Fed did nothing. Understanding why this happened is important for investors and consumers whose current debts and future financial decisions depend on where interest rates are heading.

Understanding the Fed’s decision

The Federal Reserve’s part in all this is easy to understand. Having raised interest rates by 5.25% over the past couple of years, the Fed has signaled in recent meetings that its rate target may have peaked. Further, it anticipates being able to cut rates by a total of roughly 0.75% by the end of this year.

The reason for the historic rate hikes and the anticipated rate cuts is inflation. Based on the Personal Consumption Expenditures price index (the Fed’s preferred measure of inflation), the year-over-year inflation rate peaked at 6.8% in mid-2022. In response, the Fed hustled to raise rates to dampen price increases. This required an unusually steep course of rate hikes because the Fed funds rate had been unnaturally low since the Great Recession.

The rate hikes, among other things, helped bring inflation under control. By the end of 2023, the year-over-year inflation rate was down to 2.7%. This helps explain why the Fed hasn’t raised rates since July 2023 and is now forecasting lower rates by the end of 2024. Even so, having been burned by a surprisingly intense inflation flare-up, the Fed is in no hurry to start cutting rates. Not only did the Fed leave rates unchanged at last week’s meeting, but Fed Chair Jerome Powell stated that a rate cut in their March 2024 meeting is also unlikely.

Are people rooting for bad news?

While the Fed’s decision to leave rates unchanged is easy to understand, the market’s reaction to it takes more explaining. The stock market dropped by 1.5% in response to last week’s Fed meeting. Investors had speculated that rate cuts would occur more rapidly than the Fed forecast. Last week’s decision to leave rates unchanged, plus Powell’s subsequent comments, threw cold water on some of that speculation.

Lower interest rates boost stock valuations and encourage economic activity. However, while the Fed welcomes a healthy stock market, it’s not their mission to use interest rate policy to support the market. As for economic activity, Gross Domestic Product growth was strong in the second half of the year. In essence, the Fed is judging that a resurgence of inflation is a greater threat than a recession. That’s why it is choosing to go slow on lowering interest rates.

The Fed’s decision was vindicated a couple of days later by a surprisingly strong jobs report, showing that the economy is still going strong. The setback in the stock market shouldn’t be blamed on the Fed so much as wishful thinking about rate cuts.

Powell chided speculators in his comments after the Fed meeting for thinking good news was bad news. Indeed, there have been times when good news on economic growth has prompted an adverse reaction from stocks because it reduces any urgency the Fed might feel about cutting rates. Ultimately, a strong job market should be viewed as a positive for stocks rather than a negative.

The benefits of keeping rates higher longer

While investors were hoping for a quick boost via aggressive rate cuts, the Fed’s caution about inflation seems justified. Plus, there are several benefits to keeping rates higher longer:

• Making sure inflation is dead. Generally speaking, severe inflation has more long-term negative effects than an economic slowdown, so erring on the side of firmly suppressing inflation is a good idea.
• Cooling speculation. The stock market has rallied strongly in recent months. The extreme reaction to last week’s Fed meeting suggests speculation about aggressive rate cuts was fueling some of that rally. Letting some of the air out of a speculative bubble is better than letting it get out of control.
• Creating less incentive to borrow. Lower interest rates encourage borrowing. Record consumer and government debt suggests borrowers already have plenty of incentive.
• Creating more incentive to save. The flip side of borrowing is saving. Saving rates have plunged over the past couple of years. Higher rates might encourage more savings.

As for the stock market, it has more than recovered from having its wishful thinking disappointed. In the two days following its sharp losses after the Fed meeting, the S&P 500 gained back even more than it had lost. Perhaps Friday’s strong jobs report allowed investors to treat good news as good news. Or else they found something else to speculate about.

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Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.

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The Fed announced on December 13 that it decided not to raise interest rates at this last meeting of 2023,. The stock market jumped up 500 points. Commentators hailed it as a turning point in monetary policy.

Why was doing nothing seen as such a big deal? Should you be joining those who are celebrating the Fed’s inaction?

The decision to keep interest rates steady may not yet qualify as a new interest rate policy (interest rates may yet rise again) but there could be benefits for consumers, albeit not immediately.

A possible end to an extended rising rate campaign

The decision not to raise rates again in 2023 contradicted what the Fed had previously signaled. In economic projections released in September, the Fed indicated it expected Fed rates to end 2023 at 5.6%. That would have required one more rate hike before the end of the year.

That rate hike would have been the latest in a series of 11 rate hikes totaling 5.25% beginning in March 2022. Rate hikes are unpopular with investors and consumers alike. For investors, higher rates generally reduce the present value of future earnings on their investments, which tends to decrease stock and bond prices.

For consumers, higher interest rates mean they pay more to borrow money. This hits especially hard at a time when US consumers have a record amount of debt.

One fewer rate increase than originally expected might not seem like a big deal. But along with announcing no rate hike at its latest meeting, the Fed also released a new set of economic projections. These projections signaled a turning point in the Fed’s monetary policy (and associated interest rate policy).

Compared with the Fed’s previous projections, the new outlook calls for interest rates to fall more swiftly over the next two years than previously thought. This would provide a quicker boost for investors and faster relief for consumers.

In the long run, this will be meaningful only if the Fed has succeeded in calming inflation. The new economic projections show more optimism that this is the case. Inflation has cooled more quickly over the past couple of months than the Fed had expected in its September projections. The new projections show inflation falling faster next year than previously thought.

Why investors jumped for joy

When the Fed announced the outcome of its latest meeting, the Dow Jones Industrials average jumped by more than 500 points. It followed that with a surge of over 150 points the next day. That represents a gain of about 1.8% in just two days. If that doesn’t sound particularly impressive, consider that based on the Dow’s total market value of nearly $11.8 trillion, 1.8% represents a gain of over $200 billion in under 48 hours. And that’s just the 30 stocks that make up the Dow. The broader S&P 500 and Nasdaq indexes also showed big gains immediately following the Fed’s news.

One reason for this is the way stocks are valued. Rising interest rates diminish the present value of future earnings. Conversely, falling interest rates increase the value. The news that the Fed is skipping a planned rate hike and plans to reduce rates next year led investors to place higher value on stocks. For similar reasons, bonds also get a boost from falling rates.

Besides improving how future earnings translate to market prices, the prospect of lower rates also made investors more optimistic about the size of those earnings. High interest rates act as a drag on economic growth. The economy already faces some other headwinds going into 2024. For millions of consumers, the resumption of student loan payments will make less money available for spending. Also, in the face of higher credit risk, lenders are tightening lending standards, making it tougher for people without excellent credit scores to get loans and credit cards.

If rates start to fall in 2024, it will ease the burden of consumers who rely on credit card debt. That may not prevent economic growth from slowing, but it could save the economy from tipping over the edge into recession.

Consumers should still expect to pay a price in 2024

There is reason to cheer the prospect of lower inflation and interest rates next year, but both will still cost consumers plenty in 2024.

Inflation prediction

The Fed projects a slower pace of price increases next year, but they still expect prices to increase by more than their 2% inflation goal.

The expectation is for price increases to slow and not for prices to come down. So, budgets stretched by high inflation over the past couple of years will have to be adjusted to fit future prices.

Interest rate policy

For now, the Fed has stopped raising interest rates. However, it hasn’t yet started lowering them and may not do so until well into 2024.

Americans with credit card balances will start the new year paying high rates on their balances. The average rate charged on credit cards is 22.77%. That’s the highest level since the Fed started keeping credit card rate records in 1994. Also, even after rates start to come down, previously existing balances may continue to be charged higher rates for some time.

Is the new interest rate policy just the beginning?

It’s important to be realistic about what to expect from rate cuts. Rates may come down from today’s levels but never return to where they were a few years ago.

For the 14+ years from April of 2008 through August of 2022, the Fed funds rate never once got above 2.5%. That may have come to seem like normal, but those low rates were the exception rather than the rule. Over the past 50 years, the Fed funds rate has averaged 4.8%. 4.8% is just half a percentage point below today’s 5.3% Fed funds rate. For all the talk of high interest rates, they are closer to “normal” than they have been for a long time.

Rates could fall further than the historical norm if the Fed successfully drives inflation down to 2.0%. Over the past 50 years, inflation has averaged almost twice that, at 3.9%. The 4.8% average Fed funds rate is typically 0.9% above the inflation rate. If this is the norm and inflation falls to 2.0%, the Fed funds rate could drop to 2.9%.

While that would be a substantial drop from today’s rate, it wouldn’t be anywhere near as low as rates were from 2008 to 2022. Consumers and investors need to reset their expectations accordingly.

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Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.

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