Next month will mark the longest U.S. economic expansion on record. But growing signs of a slowing economy — and potentially a recession — have some businesses concerned about the future.
Increased uncertainty is never a good thing for businesses. If they don’t know the future demand for their products or services, then they hold off on plans to hire people or purchase more equipment.
Several recession indicators bear watching.
First, the shape of the yield curve, which represents the relationship between interest rates on short-term and longer-term securities, is an important signal.
Typically, the yield on a 3-month Treasury bill is lower than on a 10-year note. That’s because there is less uncertainty over what will happen in only three months compared with 10 years.
Yield curves that are steep suggest investors are optimistic about future economic growth and are willing to purchase and hold long-term Treasury notes. In contrast, an inverted yield curve where the 3-month yield is higher than the 10-year yield points to a slowing economy. Since 1956, an inverted yield curve has preceded every recession by a year and a half or so.
In mid-March, there was a slight inversion of the yield curve when the 3-month Treasury bill rose above the 10-year note. It lasted only two days and the curve had been fairly flat until May 23 when it inverted once again. As of June 3, the yield on the 3-month bill was 0.28 percentage points above the 10-year note.
The stock market is another indicator that typically falls before a recession because investors reduce equity holdings when they expect corporate profits to fall.
The S&P 500 fell about 12 percent in December and then rebounded in 2019. Since the beginning of May, it started to decline once again and was nearly 7 percent off its highs by the end of May. However, caution is needed when interpreting the change in a single indicator. As economist Paul Samuelson famously said, the stock market has predicted nine of the past five recessions.
An economic index by Chmura Economics & Analytics that predicts the probability of recession six months forward rose to a 21 percent probability of a recession in November 2019 because of the recent drop in the S&P 500 and the narrowing yield curve.
This is a 17-percentage-point increase from the prior month. But the index number is close to what it was earlier this year when it was a 26 percent probability in January and February and a 25 percent probability in March.
A single month of elevated probability in the index provides a warning that the economy is likely to slow.
The index uses the consumer price index, the spread of the Treasury curve, volatility in the Treasury curve, and the S&P 500 to predict when financial conditions are ideal for a recession. A sustained six-month period of greater than 50 percent probability establishes a clear sign that has historically been associated with recession.
The National Bureau of Economic Research is the official arbiter of recessions. The agency looks at indicators such as gross domestic product, real income, employment, industrial production and real retail sales to determine if the nation is in recession.
Currently, each of these indicators show economic growth. Real GDP grew an annualized 3.1 percent in the first quarter of 2019, and first-quarter real disposable personal income was 2.2 percent higher than the previous year.
The monthly indicators were all higher compared to a year ago in April: Employment rose 1.8 percent, industrial production increased 0.9 percent, and real retail sales were 1.1 percent higher.
Most of these indicators are holding steady or growing. Industrial production is the only indicator that is showing a worrisome slip from a strong 5.4 percent year-over-year pace in September.
Economists often talk about “headwinds” that may slow growth. Perhaps the greatest headwind to growth at this time is tariffs that will raise the price of goods consumed in the U.S. as well as potentially disrupt the supply chain of inputs needed to produce goods in the U.S. such as automobiles.
We don’t expect a recession in 2019, but there are enough warning signals to raise the caution flags.
A version of this commentary originally ran in the June 9, 2019 edition of The Richmond Times-Dispatch.
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