The Fed Just Paused Interest Rate Hikes. Do We Still Need to Worry About a Recession?

If it seems like you can't read the news without hearing the word "recession" thrown into the mix, it's because many financial experts remain worried about a near-term economic decline. And the Federal Reserve's interest rate policies are no doubt playing a role in that line of thinking.

The Fed has raised interest rates 10 times since March 2022 in an effort to cool the pace of inflation. In June, however, the Fed made the decision to pause its interest rate hikes. But that may not be enough to prevent a widespread economic downturn.

Why a one-time pause on rate hikes may not provide much relief

What do interest rate hikes have to do with a recession? A lot, actually.

The Fed has raised its federal funds rate 10 times since last March, which has made it more expensive for banks to borrow from each other on a short-term basis. That, in turn, has resulted in banks and lenders passing higher borrowing costs on to consumers.

These days, it costs more money to carry a credit card balance, sign a personal loan, or borrow to buy a car. And until the Fed lowers its benchmark interest rate, consumers might continue to struggle.

The fear, however, is that persistently higher borrowing costs will drive consumers to start spending less money. If broad spending declines to a notable degree, it could be enough to fuel a recession. And that might happen even if the Fed opts not to raise interest rates at its next meeting this year.

That's also a big "if." In May, annual inflation, as measured by the Consumer Price Index, was at 4%. But the Fed has made it clear that it will continue to target 2% inflation, which is the level it feels is most conducive to economic stability on a long-term basis. And while 4% annual inflation might seem like it's close to the Fed's target, without a nudge in the form of more rate hikes, the central bank may not get what it wants.

How to gear up for a recession

While the Fed's recent rate hike pause might offer some relief to consumers in need of personal loans, the reality is that it's probably not enough to avoid a recession. This doesn't mean that we're guaranteed to experience a downturn this year. But it's something consumers should prepare for.

A good way to do so is by boosting your savings account balance. Recessions tend to lead to an uptick in unemployment. Having solid emergency savings -- ideally, enough money in the bank to cover at least three full months of essential expenses -- is a good way to get through a period of joblessness unscathed.

Consumers should also avoid taking on large purchases now, and instead conserve cash. Besides, it's clearly not a very good time to finance a big purchase, so even those with full emergency funds may want to consider holding off.

The Fed itself said in the spring that it expects a recession to strike in 2023, albeit a mild one. Although that's not set in stone, it's a possibility everyone should brace for -- even if the central bank doesn't end up raising interest rates again this year.