Will Rate Hikes Cause a Recession? Here’s How to Prepare

(Bloomberg) -- The U.S. Federal Reserve just raised interest rates by the most in 22 years, prompting fears that a recession is around the corner.

The goal is to tame roaring inflation, but many have expressed doubt that the Fed will manage to orchestrate a so-called “soft landing” — lowering prices without damaging the economy. As those questions swirl, financial advisers say it's a good time to prepare for a possible financial downturn.

“Any time you move to a period of monetary tightening or restraint, you need to dust off the recession checklist,” said Liz Ann Sonders, chief investment strategist at Charles Schwab. “There's ripple effects into everything, not to mention the psychological impact for the consumer.”

What's a Recession?

The “R” word invokes fears of job losses, plunging stock markets and economic pain. Much of this stems from consumers' relatively recent experiences with the long, slow exit from the 2008 financial crisis, which was dubbed the Great Recession.

“Recession” is a technical term, defined as two consecutive quarters of shrinking gross domestic product. The National Bureau of Economic Research is the authority that declares recessions in the U.S., and its own definition is “significant decline in economic activity that is spread across the economy and that lasts more than a few months.”

Different people will feel the effects of a recession in different ways depending on their circumstances, jobs and locations.

“Many people have gone through many true recessions without actually feeling the impact of it,” said Colin Moynahan, a financial adviser for Twenty Fifty Capital in Charleston, South Carolina.

In other words, panicking about the possibility of a recession could be counter-productive. But it pays to be ready.

Spending Strategy

Even with the risk of recession in the air, data show that Americans are still spending at a healthy clip. U.S. inflation-adjusted consumer spending rose unexpectedly in March. And the country's largest banks recently reported that credit-card spending surged in the first quarter.

Advisers say it might be time to cut back on some of those expenses. It's part of a financial strategy that effectively follows the old adage of “making hay while the sun shines.”

“The hardest part is changing your behavior proactively enough to get ahead of it versus trying to play catch up,” Moynahan said.

That could mean figuring out ways to cut back on discretionary spending or identifying purchases that are priorities rather than desires. Vacations and eating out are usually some of the first areas to be trimmed, he said.

Prepare Your Portfolio

In a recessionary environment, the classic 60/40 portfolio — 60% stocks and 40% bonds — is supposed to shine. That's because recessions normally prompt rate cuts, which are good for bond prices. That's not the case this time, as rising rates have caused bonds to plunge, said Christopher Grisanti, chief equity strategist at MAI Capital Management.

“The 40 part which is supposed to protect you has done as badly as the 60 part,” he said.

Grisanti is a fan of tilting portfolios more toward equities right now, since they often do well in an inflationary environment. But he advises against taking on too much risk. Those who insist on stock picking should be sure to choose companies that have already reported earnings, he said, since “the market has been unforgiving of shortfalls.”

Real Estate

One of the Fed's main goals in raising interest rates is to cool the housing market, which has exploded since the pandemic began. In February, the latest month for which data is available, a measure of prices in 20 U.S. cities rose 20.2% from the year prior.

Does it make sense to buy a home with the risk of a recession looming? Buying now could mean locking in mortgage rates before they rise even higher. But it could also mean taking on debt for an asset when prices are high, only to see its value decline in the months ahead.

Everyone's situation is different, but advisers generally say buying a home that you can afford and that you plan to stay in for the long-term could make sense even if there is a recession ahead. Buying a home you plan to keep for just a few years might not.

Moynahan of Twenty Fifty Capital says someone buying a home to live in for a period of around five years would need that property to appreciate by quite a bit to make back closing costs and turn a profit. That would become even more difficult if a recession happens in the months ahead and lowers demand for housing.

Should You Quit?

At this point in the Great Resignation, many people have already quit jobs they can't stand. Those who fear a downturn in the months ahead might worry that leaving their roles now could leave them exposed to a recessionary job market, unable to be rehired easily. Advisers say those fears are overblown.

“We're not seeing any let-up in the strong employment situation,” Grisanti said. “It's the best time in a generation to be an employee.”

In March, U.S. employers saw a record level of job openings, with 1.9 jobs available for every unemployed worker. At the same time, wages and salaries increased 4.7% in the first quarter.

Still, not all industries would respond the same to a downturn, said Matt Miskin, co-chief investment strategist at John Hancock Investment Management. Consumer-focused industries like retail and hospitality might be more risky in terms of job stability.

“If the company is very tied to the economy, I would think carefully about making that jump,” he said. “Even if they say you have the job right now, they could be downsizing next year.”