Four indicators for the next US recession

Wall Street
By Andrea Murad, CA Today

10 January 2018

Almost 10 years have passed since the Great Recession and the severity of the last downturn set the stage for a lacklustre recovery, making the US economy susceptible to mild shocks. It might not take much to push the economy off this recovery trajectory - we look ahead to potential red flags for 2018.

“If you’re talking about an overall national recession, the signs haven’t changed,” said John Silvia, Chief Economist for Wells Fargo. “You’d have to see something going on with leading economic indicators, the purchasing manager indices and jobless claims. You’d have to see some change in those patterns in terms of a signal of a recession coming nine months ahead.”

In the past, movements in GDP have been good predictors of what happens to labor markets and prices, which is partly where traditional notions of decline in GDP come from.

If we have a substantial correction in equity markets and rates spike, that could undermine the expansion.

“Recessions are like snowflakes - no two recessions are identical in length, severity or catalyst,” said Ryan Sweet, Director of Real-Time Economics at Moody's Analytics. “The metrics we look at haven’t changed appreciatively, but some of the inputs have changed over time. Recessions are triggered by shocks, and those are unpredictable.”

The seeds of cause for a new recession tend to be planted during the recovery, and they can be found in four key areas.

1. Financial Markets

There’s more emphasis on financial markets today, and the conditions are very loose and supportive for economic activity.

“If we have a substantial correction in equity markets and rates spike, that could undermine the expansion,” said Ryan. “But if everything goes according to plan, financial markets will tighten, though that won’t trigger a recession in the next year.”

2. Labor markets

The job market hasn’t shown signs of slowing, however, longer-term dynamics are at play.

Initial claims of unemployment insurance are a good indicator of job growth and economic activity - a red flag is raised when this number reaches 300,000 while the unemployment rate rises month after month, Ryan explained.

The participation rate or employed population figures, rather than the unemployment rate, shows a slightly different dynamic. In the past, the participation rate has been relatively constant while the unemployment rate changes in a boom or recession. Today, the participation rate is declining, suggesting that underemployment is increasing.

Recessions are like snowflakes - no two recessions are identical in length, severity or catalyst. Recessions are triggered by shocks, and those are unpredictable.

“There are signs that the unemployment rate might look rosy, but when you look at broader indicators, this is not an economy that’s racing off the blocks,” said Vaidyanathan Venkateswaran, Assistant Professor of Economics at New York University’s Stern School of Business.

This won’t lead to a recession over the span of a couple of quarters but any booms will be less intense and traditional metrics like GDP and profits will be muted.

3. The Federal Reserve and Inflation

A tight labor market that can potentially drive up wages and inflation has been motivating the Fed’s moves these past few months. “The [Federal Open Market Committee] members look at these overarching weaknesses and people who are choosing to stay out of the labor force - the implications of that aren’t clear at this point,” said Vaidyanathan. “This means that the Fed will always be a little bit cautious.”

If you see inflation numbers going towards below 1%, then you have to ask questions about the strength of the economy.

The Fed is estimating that inflation will move towards 2%. “The argument is that inflation being as low as it is, is transitory,” said John. However, there is evidence that this is a longer-term issue. “If you’re not getting the inflation numbers to 2%, they probably won’t be raising rates in 2018 three or four times, like they currently project. If the issue is you’re not going to get 2% inflation, any run off they have in their balance sheet will be much less than what they currently project.”

Inflation seems to be doing fine as there’s economic growth, low unemployment and improving household incomes. “If you see inflation numbers going towards below 1%, then you have to ask questions about the strength of the economy and why prices are declining,” said John. In this case, the US would be in a more deflationary environment and the pace of economic growth would be an issue.

4. Policy

Financial markets have been doing well in anticipation of reforms for tax and healthcare and increased spending on infrastructure and defense, said Ryan.

The President can affect trade policies though, and any renegotiation on trade agreements is yet to be seen. The US manufacturing sector relies on imports for the supply chain, and “if Trump looks to improve our trade deficit by hurting imports, manufacturing in the US will be hurt by restriction,” Ryan concluded.


About the author

Andrea Murad is a New York–based writer. Having worked on both Wall Street and Main Street, she now pursues her passion for words. She covers business and finance, and her work can be found on BBC Capital, Consumers Digest, Entrepreneur.comFOXBusiness.com, Global Finance and InstitutionalInvestor.com.

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