How to Predict a Recession

With multiple indicators that point to market anxiety, including the recent coronavirus outbreak that has stoked fears of a slowing economy in China, recession speculation always makes the various media circuits and market watchdogs. But can you predict a recession? The answer is complicated. There are multiple factors that can be markers of a potential recession, but it is no exact science.

A recession is generally defined as two consecutive quarters of negative growth, but recessions can vary in depth and scope. There are different sets of possible recession indicators monitored or measured by various bodies.

 

Recession Indicators

Unemployment rate measurements such as the monthly job report from the U.S Department of Labor’s Bureau of Labor Statistics give a picture of how the economy is faring. For example, in January the Department of Labor released the jobs report adding 225,000 nonfarm payrolls for the month, which beat Wall Street expectations. This inspires confidence as economists want unemployment to be low. Another employment-related measurement is the Institute for Supply Management’s gauge of manufacturing orders.

The U.S. Treasury yield curve is another important indicator. It is defined as the spread between long- and short-term Treasury bonds. The yield curve turns negative when near-term Treasurys yield more than their long-term counterparts. Or, to put it another way: when long term-term bonds—traditionally those with higher expected yields—see their returns fall below those of short-term bonds. Although it can take up to 34 months for a recession to hit after the curve inverts, it can be one of the first signs an economy is shrinking, and has preceded every recession since 1950.

The U.S. Federal Reserve monetary policy is an important variable when considering recessions. Typically, “loose” monetary policy is when interest rates are lower to stimulate growth. The current interest rate level is set to 1.5 – 1.75%. In the United States, the federal funds rate is the interest rate at which banks lend reserve balances to other depository institutions overnight on an uncollateralized basis. A central bank’s monetary policy can contribute to inflation, which is a rise in average price levels of goods and services in an economy. Sustained inflation happens when a nation’s money supply growth outpaces economic growth, which is considered a sign of a weakening economy.

 

Other Variables

Corporate profit margins are watched closely to ensure business is healthy. International events such as the novel coronavrius outbreak can scare the market because it slows China’s economy which affects other countries’ economies by interrupting supply chains. Similarly, trade tensions such as the U.S.-China trade war, or the exit of the U.K. from the European Union, can also affect economic performance.

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Disclaimer: The writer is an experienced financial consultant who writes for Finscreener.org. The observations he makes are his own and are not intended as investment or trading advice.