Are Economic Indicators Signaling a Recession?

Investment banks are sounding the alarm on a looming recession while consumers worry about soaring inflation diminishing their purchasing power, a plummeting stock and bond market, slow GDP growth, rising interest rates, and an equity market decline. But what do actual economic indicators of recessions currently say about the likelihood of sliding into a recession? Is market volatility and inflation expected to subside? 

Recessions are marked by downturn in economic activity, and officially declared after two consecutive quarters of negative GDP growth rates by a committee at the NBER. There are mounting worries that rising borrowing costs for consumers and businesses, could cause a sudden recession. Investors fear the slowdown in economic activity could lead this way, but what do the GDP growth rate, employment rate, inflation forecasts, interest rate changes, and yield curve actually signify?

While the market and inflation are doing unnerving, it is unlikely that the U.S. economy will enter a recession for various reasons. The New York Federal Reserve currently forecasts a 3.7% chance of a recession within 12 months. The bad news is true — GDP growth slowed in the first quarter of 2022, rising only by 0.1% quarter-on-quarter, a downturn from the 1.2% increase in the fourth quarter of 2021. Inflation slowed last month to 8.3%, with prices at a four-decade high, and gas at an average of $4.40 per gallon. Additionally, the S&P 500 has fallen nearly 20% this year, and the Bloomberg Barclays Aggregate Bond Index has dropped 11% since its January 2021 peak. But are these indicators of a looming recession or temporary effects of the Fed’s monetary policy to reign in inflation, which helps consumers in the long-term?  

Monetary Policy to Blame for GDP Slowdown and Stock & Bond Market Downturn

Both the GDP growth slowdown and stock market plunge are simply a result of the Federal Reserve’s interest rate hikes implemented to combat the very inflation eating away consumers’ purchasing power. The Fed raised interest rates to 0.25%-0.50%, and said the federal funds rate could reach 2.5% of higher by the end of 2022. Because of this, GDP growth predictions for 2022 have been lower. 

The Fed raises interests to lower inflation by slowing down spending to slow demand down in balance with supply which has been limited by supply chain shortages through the pandemic.  People buy fewer homes and cars and companies reduce hiring and pay increases. Ten-year Treasury yields surged from 1.5% at the end of 2021 to over 3.0%, thereby forcing the Fed to raise rates faster and reduce bond holdings, subsequently lowering overall bond demand causing it to drop 11%. These hikes not only affect GDP growth but also the stock market. Rate hikes make investors move their money into bonds and out of stocks, causing them to fall. Rising bond yields create a greater discount on future profits. 

Gas Price Inflation

Gasoline prices are mainly Putin’s fault. Russian invasion of Ukraine has pushed oil prices higher worldwide. Core inflation (food and energy) is actually only 6%. President Biden has released gasoline from strategic petroleum reserves. By looking at futures prices, the market predicts that oil prices will come down.

Recession Indicators: 

There is a 3.7% chance of a recession as forecasted by the New York Federal Reserve. 

Early Signs: 

Later signs:

-3-month/10-year yield curve inversion

-High yield spreads widen

-Unemployment rises

Good Indicators

While there are some recessionary signs, many other indicators say the opposite.The consumer (70% of the economy) and labor market remain strong with 50-year-low unemployment of 3.2% and increased wage growth across all sectors, with incomes rising 0.4% in April. (However, nominal raises haven’t kept up with inflation.) Consumer spending is also robust — Americans boosted spending by 0.9% in April. Even after factoring in inflation, it rose at a strong pace. Moreover, consumers have about $2.3 trillion of excess savings accumulated during the pandemic they could continue spending over the coming years.

Moreover, the latest Treasury curve inversion was caused by fixed income markets awaiting Fed interest rate hikes. There has also been no inversion for the three-month vs. two-year yielded curve. New housing constructions continue to grow, and banks have not limited their lending. Corporate profit margins (which peak a year before a recession) have also remained stable. Historically, the stock markets decline over 33% from peak ahead of a recession, but Nasdaq has not declined over 20%.

While yields on 10-year and 2-year Treasuries are getting closer, there’s still a large gap between 10-year and 3-month Treasuries. Both parts of the curve ended to flatten and invert before we are at risk of a recession.

A former senior adviser at the U.S. Department of the Treasury believes that while the likelihood of a recession is low, it’s more likely the U.S economy falls into a “garden variety recession,” not a 2008-level financial crisis. This is what happens when the Federal Reserve increases interest rates to lower inflation caused by rapid economic growth. The more severe kind is a “balance-sheet recession” marked by mass unemployment, and consumers using their income paying down a sudden “debt bubble” instead of growing economic activity. Moreover, the 2008 recession was caused by bad housing crisis debt and since then the Dodd-Frank Act and consumer protections have been instituted.

While leading indicators can send mixed signals while exciting a global pandemic, necessary interest rate hikes intended to curve inflation are the culprit for the GDP growth and stock market decline.