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July 2024 Recession Watch Thumbnail

July 2024 Recession Watch

Many people see recessions as unexpected events that can disrupt their careers and finances. However, several reliable indicators can signal a potential economic slowdown. Below is a summary of these indicators and whether they have been triggered. Further explanations and available graphs are provided below the summary.

What is a recession? A recession is a period of economic decline marked by reduced industrial activity, decreased consumer spending, and rising unemployment, typically lasting for at least two consecutive quarters. It's important to note that no single indicator can predict recessions with absolute certainty. Therefore, we consider multiple indicators together to inform our investment decisions.

Summary of Indicators:

  • 10-2 Year Treasury Yield Curve Inversion – Triggered July 7, 2022
  • 10 Year-3 Month Treasury Yield Curve Inversion – Triggered October 25, 2022
  • Federal Reserve Bank of New York US Recession Probability – Triggered December 1, 2023
  • The Piper Sandler Recession Indicator - Triggered April 26, 2024
  • Sahm Rule Recession Indicator - Close to being Triggered
  • The Conference Board's Leading Economic Index (LEI) – Not Currently Triggered
  • GDP-Based Recession Indicator - Not Currently Triggered
  • National Bureau of Economic Research (NBER) – Not Currently Triggered

Explanations and Details:

An inverted yield curve, where short-term interest rates are higher than long-term rates, is a key economic sign because it has often predicted recessions. In 1986, Dr. Campbell Harvey, a finance professor at Duke University, found that the inversion between the 10-year Treasury Bond and the three-month T-Bill was a reliable recession predictor. His model was first based on data from four past recessions. Since then, the model has correctly predicted four more recessions without any false signals, including the recession during the COVID-19 pandemic. On average, the yield curve has been inverted for about 12 to 18 months before a recession starts. The current inversion, which began on October 25, 2022, has lasted for over twenty-one months, marking the longest period of inversion without a recession. This long inversion suggests that investors expect slower economic growth and lower inflation in the future, leading them to lock in long-term rates even if they are lower.

The New York Fed's U.S. Recession Probabilities Report is an important economic indicator that estimates the likelihood of a recession within the next 12 months. This report is based on the yield curve spread between the 10-year Treasury note and the 3-month Treasury bill. The methodology was developed by economists Arturo Estrella and Frederic Mishkin, who showed that an inverted yield curve—where short-term interest rates are higher than long-term rates—has historically been a reliable predictor of economic downturns. The current U.S. recession probability over the next twelve months is 51.82%, which may seem like a coin flip until you consider that the long-term average is 14.80%. The probability has never reached this level without a recession following.

The Piper Sandler Recession Indicator is a predictive tool developed by the investment bank Piper Sandler. It assesses the likelihood of a U.S. recession by analyzing various economic factors, including interest rates, unemployment rates, and other key economic data. By gathering and interpreting this data, the indicator aims to provide insights into the potential timing and severity of economic downturns. Financial professionals use this indicator to guide investment strategies and economic forecasts, helping to anticipate market conditions and manage risks associated with economic cycles. (No Chart)

The Sahm Rule Recession Indicator, developed by economist Claudia Sahm, serves as a coincident indicator that identifies the start of a recession often before the National Bureau of Economic Research (NBER) makes its official declaration. This rule is triggered when the three-month moving average of the U.S. unemployment rate increases by 0.5% or more from its lowest point in the preceding 12 months. Recently, this indicator has shown an upward trend and is close to being triggered, though it has not yet reached the threshold to confirm that the economy is in recession.

The Conference Board's Leading Economic Index (LEI) for the U.S. fell by 0.5% in May 2024, following a 0.6% decline in April. The drop was mainly due to reduced new orders, weak consumer sentiment, and lower building permits. Despite the continued decline, the LEI does not currently signal a recession. The Coincident Economic Index (CEI) increased by 0.4%, reflecting a positive trend in payroll employment, personal income, and industrial production. The Lagging Economic Index (LAG) slightly decreased by 0.1%.

Two consecutive quarters of negative GDP growth, known as a "technical recession," have been a common indicator of economic downturns since the 1970s. While this metric is straightforward and measurable, it's not the official definition used by economists or the National Bureau of Economic Research (NBER) in the U.S. The NBER considers a broader range of factors, including employment, income, and industrial production, to date recessions. Historically, the two-quarter GDP decline has reliably predicted recessions, with only one exception since 1948. This makes it a timely and generally accurate, though simplified, indicator of economic contractions.

The National Bureau of Economic Research (NBER) is a private, non-profit organization widely known for its role in dating recessions in the United States. Unlike the common "technical recession" definition of two consecutive quarters of negative GDP growth, the NBER uses a more comprehensive approach. It considers a range of economic indicators, including employment, real income, industrial production, and wholesale-retail sales, to determine the start and end of recessions. By analyzing these various factors, the NBER provides a more nuanced and accurate assessment of economic health. This thorough methodology ensures that recession dating reflects broader economic trends rather than relying solely on GDP figures. However, it's important to note that by the time the NBER declares that a recession has begun, it is generally obvious to most observers, and the economy is often already well into the downturn.

While many are optimistic about avoiding a recession and achieving a rare economic "soft landing," it's important to consider the lagged effects of the Federal Reserve's rate hikes. These lagged effects mean that the full consequences of higher interest rates take time to filter through the economy, affecting everything from consumer spending to business investments. Despite the optimism, these effects are and will continue to weigh on economic activity even after the Fed cuts rates. We will continue monitoring these and other economic indicators for signs of inflection in the economy and markets.