What’s with all the recession talk?
August 26, 2019
The dreaded ‘R’ word is making headlines again. Recession.
Warnings of a potential recession are certainly not new, but a recent report from the National Association for Business Economics (NABE) has given fresh cause for concern.
The report, which was released August 19, found that a majority (74%) of American business economists think the US will be in a recession by the end of 2021.
Of the economists surveyed, 38% said they believe a recession will occur in 2020. That prediction level is down slightly from 42% in the NABE’s February report. An additional 34% think that a downturn will come by 2021, an increase from 25% who responded the same way in February. Only 2% of those polled believe a recession may occur before the end of this year.
Given that the trade dispute with China has contributed to economists’ concerns, it’s worth noting that the survey was conducted just before the announcement of 10% tariffs on an additional $300 billion worth of Chinese goods.
Of course, not everyone thinks a recession is likely, including President Donald Trump.
“I don’t think we’re having a recession,” the President told reporters the day before the NABE report came out. “We’re doing tremendously well. Our consumers are rich. I gave a tremendous tax cut and they’re loaded up with money.”
It’s true that the US economy is currently doing well. After all, unemployment is low, which helps boost consumer spending – the driving factor for a healthy economy. But it’s also true that some recession warning bells have already started going off.
Here’s a look at a few of the indicators worth paying attention to.
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Inverted yield curve
The inverted yield curve has long been viewed as the quintessential indication that a recession is looming.
An inverted yield curve occurs when yields (returns that investors get) on long-term bonds fall below those on short-term bonds. This situation is unusual since investors typically demand higher returns from long-term bonds because of the greater risk that comes with having their money locked up for a longer period of time. As CNN explained: “It’s not normal for investors to demand higher rates on short-term loans, which are supposed to be less risky.”
An inverted yield curve is usually seen as an interpretation that the market expects limited growth in the coming years.
Earlier this month, the yield on 10-year Treasury bonds dropped below the yield of the two-year Treasury. It was the first time that section of the yield curve inverted since 2007, and put investors on high alert. The yield curve did recover and then it inverted again in late August, further fueling recession fears.
What’s more, the three-month and 10-year Treasury yields have been inverted since the spring.
So, what kind of track record do inverted yield curves have for forecasting a recession? Eerily accurate. Yield curve inversions have preceded every recession since 1955.
According to researchers from the Federal Reserve Bank of San Francisco: “Forecasting future economic developments is a tricky business, but the term spread has a strikingly accurate record for forecasting recessions. Periods with an inverted yield curve are reliably followed by economic slowdowns and almost always by a recession.”
But while the scenario gives a probable indication that a recession is brewing, it doesn’t predict when one will occur. The time between an inverted yield curve and the beginning of a recession has ranged between six and 24 months.
Recession probability index
Another top indicator of a recession on the horizon has been the New York Federal Reserve’s recession probability index breaking 30%.
That economic barometer reached more than 31% in July. While that represents a slight improvement from the 32.9% reading in June, which was the highest level reached since 2009, it certainly doesn’t mean things are in the clear.
Why’s the New York Fed recession probability so important? Before every recession since 1960, the index has recorded a reading above 30%.
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Things are looking less than stellar on the global economic stage. And while that doesn’t automatically indicate the US will enter a recession, it doesn’t help things.
As Bloomberg recently noted: “China reported the weakest growth in industrial output since 2002. Germany’s economy shrank as exports slumped, and euro-area production plunged the most in more than three years as the overall expansion cooled.”
While there’s no certainty that the world economy will enter a recession, global growth has certainly slowed. The International Monetary Fund has said the global economy is at a “delicate moment.”
Economies around the world are connected via trade. And that, in turn, means that the US isn’t immune to the ripple effects of a weakening global economy. Especially considering that falling business investment, stemming from concerns about global growth, dragged on US economic growth in the first half of this year.
Another sign of trouble has come from the manufacturing sector.
This month, US manufacturer growth slowed to the lowest level in nearly 10 years. The US manufacturing PMI (purchasing managers’ index) was 49.9 in August, the first time it has dropped below the neutral 50.0 mark since September 2009. Any reading below 50 means the sector is contracting.
And while the sector was averaging 22,000 new jobs a month in 2018, this year it’s down to a monthy average of 8,000, according to the latest data from the Labor Department.
Analysts say the sector has been impacted by rising tariffs, which has caused costs to increase, as well as declining purchases from overseas due to the global slowdown.
Historically, the manufacturing sector index has shown a decline before a slowdown in the broader economy.
Do any of these indicators prove that a recession will absolutely happen? No. But they do indicate the cause for concern is justified. Especially since the one thing that all forecasters can agree on is that we only know a recession is happening once we’re already in one.
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