Looming Recession For Small Businesses? Optimism Index Hits 10-Year Low

Topline

As stubbornly high inflation and a tight labor market weighed on sales and earnings, small business sentiment plummeted to the lowest level in a decade last month—a worrying sign that Main Street may become the latest facet of the economy to take a major blow amid the Federal Reserve’s economic tightening campaign.

“From a wider perspective, the Fed created the problem,” economists at the National Federation of … [+] Independent Business said Tuesday.

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Key Facts

The Small Business Optimism Index fell by 1.1 points in April to 89—hitting the lowest level in just over 10 years, as business owners reported dampened expectations for the broad economy, sales and earnings, the National Federation of Independent Business reported Tuesday.

The biggest source of concern was the labor market, with 45% of owners reporting job openings they couldn’t fill last month (compared to 43% in March), and inflation was a close second, as 33% of owners said they raised average selling prices.

In emailed comments, Pantheon Macro chief economist Ian Shepherdson said the report signals a looming recession for small businesses, with the “most worrying” data point showing capital expenditures (or investments in physical assets like buildings and equipment) fell to within just one point of the low during the Covid-induced recession in 2020.

“The rapid downward trend [in] recent months is alarming,” he said, pointing to a “similarly grim trajectory” for such spending in data from the Fed as another indication that business investments—a major component of economic growth—is “set to fall outright, if it isn’t already.”

There was also some good news: Fewer respondents said loans were harder to get in April, as compared to March (when the rash of recent bank failures started), but Shepherdson notes interest rates for short-term loans—at 8.5%—are the highest they’ve been since October 2007, meaning credit is still expensive and will inevitably crimp firms’ spending power.

Key Background

Over the past year, the Fed’s interest rate hikes have triggered steep downturns in the housing and stock markets, and some experts fear the higher borrowing costs could ultimately trigger a recession. Economic growth in the first quarter slowed to an annual rate of 1.1%—far less than economists projected and also below 2.6% growth reported in the third quarter. Declines in the housing market and business investments were among factors leading to the worse-than-expected growth last quarter, according to the Bureau of Economic Analysis. And even Fed officials last month said they now expect the U.S. will fall into a “mild recession” later this year.

Chief Critic

“From a wider perspective, the Fed created the problem,” the NFIB’s William C. Dunkelberg and Holly Wade said on Tuesday, blaming the central bank for keeping rates low for years—only to suddenly start rapidly increasing them after inflation broke out. “Now, the economy appears to be slowing.”