• The US is charging toward a full economic recovery, but there are still some flashing warning signs.
  • Supply-chain issues, the labor shortage, and inflation all present major risks to the rebound. 
  • Here's how each of these risks could derail the recovery and even spark a new downturn.

The US economy is still squarely in recovery mode, but there are some seriously big bumps in the path forward.

While the jobs rebound is nearly complete, spending sits at record highs, and worker pay is still climbing at a stronger-than-usual pace, there is one weak spot: Thursday's disappointing first-quarter GDP decline. However, the scary headline number was also largely powered by temporary factors, like a dip in demand for US exports and a slowdown in businesses restocking their inventory.

Economists generally expect a return to growth through 2022 — but three risks are flashing signs that the recovery could be derailed.

The global supply chain is still badly tangled

It's still difficult to get stuff shipped around the world — and a lot of it is still thanks to Covid-19. If supply chains aren't fixed, it could leave the economy growing at a slower rate for the foreseeable future because consumers and businesses simply won't be able to buy as much.

The logistics issues first emerged in the middle of 2021 when the Delta wave led to new factory closures throughout China. That powered shortages of key components like semiconductors, and the entire supply chain quickly got backed up as more countries faced increased infections and reinstituted partial lockdowns. Shipping delays, widespread shortages, and higher prices ensued.

The Omicron variant extended the tangle, and rising virus cases in China threaten to repeat the cycle all over again. Lockdown measures have already been revived in Shanghai and Shenzen, the latter of which serves as one of the world's biggest manufacturing hubs.

Intensifying supply chain woes would leave the US to contend with greater inflation pressures and another round of product shortages. Americans could rein in their spending amid even higher prices, and the lack of activity would endanger businesses still recovering. In the worst-case scenario, spending would contract so much that the entire economy enters a new recession.

It's no wonder, then, that the events of the past year have countries mulling a shift away from globalization

Businesses are so desperate to hire that they could raise wages so much they exacerbate inflation

The labor market's recovery has been three times faster than that seen after the Great Recession, but it's coming up against some snags.

Chief among them is the sluggish improvement in labor force participation. The measure tracks the proportion of Americans either working or looking for work. The slow rebound set the foundation for the labor shortage, as last year's reopening saw businesses try to rehire from a considerably smaller worker pool. The months since have seen payrolls rocket higher, but participation remains well below pre-crisis levels.

The extreme tightness in the labor market helped workers win above-average raises and new bargaining power, but now it's posing some issues. The gap between job openings and available workers is now at "an unhealthy level," Federal Reserve Chair Jerome Powell said in March. If participation remains weak and consumer demand stays elevated, businesses will continue to drive wages higher and, in turn, boost inflation.

"More labor force participation is tremendously welcome," Powell added. "It will, we think, help relieve some of the wage pressures that do put inflation at risk."

Prices are still soaring

While several trends could throw the recovery off-kilter, they all come down to inflation. Price growth has quickly replaced the coronavirus as the biggest obstacle toward a full recovery, and it poses the biggest risk of sparking a new recession.

Prices for everyday goods and services climbed 8.5% in the year through March, marking the fastest pace since 1981. A bevy of factors, including the aforementioned supply-chain and labor shortage pressures, could speed the pace further still. Russia's invasion of Ukraine could also worsen the problem, as it's already boosted prices for key commodities including oil, wheat, fertilizer, and nickel.

Even efforts to cool inflation threaten to drag the US into a downturn. The Fed raised interest rates in March in hopes that higher rates will ease demand and pull inflation to healthier levels without harming employment. The central bank is likely to move more aggressively in the months ahead, with Powell hinting earlier in April that a double-sized rate hike is "on the table" for the Fed's May meeting.

But critics fear the plan will backfire. Raising interest rates too quickly can weaken demand so much that businesses stop hiring. In the fight to cool inflation, the Fed could spark an entirely new crisis.

The central bank is already playing catch-up with inflation and economic harm is now "virtually inevitable," Bill Dudley, a Bloomberg opinion columnist and former president of the New York Fed, said in a March 29 column.

Deutsche Bank economists were even blunter. The team sees the Fed's rate hikes inducing a recession by the end of 2023, according to a Tuesday note.

"The risks to this outlook seem clearly skewed to the downside — for a more severe recession," economists led by David Folkerts-Landau said.

To be sure, some signs suggest inflation has already peaked. Data out Friday showed core personal consumption expenditures — the Fed's go-to inflation measure — rising 5.2% in the year through March, slowing from the prior month's 5.4% pace.

But even if price growth is already starting to cool, it has a long way to go before reaching sustainable levels. Until then, the warning signs flashing throughout the economy could undo much of the recovery progress seen over the past two years.

Read the original article on Business Insider