Reading the Economic Tea Leaves: Is a US Recession Around the Corner?

Introduction

The specter of a looming recession in the United States has been haunting economic discussions for more than a year. While the recession has not yet materialized, it’s essential to acknowledge the historical lag between Federal Reserve interest rate hikes and their impact on the economy. This lag often spans 12 to 18 months, which is why the signs of a mild recession may be on the horizon. In this article, we will examine various economic indicators that can shed light on the possibility of a recession and provide insight into the current state of the U.S. economy.

The State of Economic Indicators

Economic indicators play a crucial role in predicting and understanding the economic landscape. As we assess the potential for a recession, we find that these indicators provide a mixed picture of the U.S. economy, with both positive and negative signals. Let’s delve into some of the key indicators:

1. Inflation Expectations: One of the vital signals of economic health is inflation expectations. When expectations rise significantly, it often triggers monetary policy tightening cycles, which can hasten the end of business cycles. Fortunately, inflation expectations have notably declined, signaling a potential end to policy tightening.
2. US Treasury Yield Curve: The shape of the U.S. Treasury yield curve is often a reliable harbinger of economic woes. Currently, we are in the third step of the typical recession pattern, where the spread between the 10-year and 2-year Treasury rates has inverted. This is historically followed by a recession within 1 to 2 years.
3. Credit Spreads: Credit markets often act as early warning signals for economic downturns. While credit spreads have widened modestly, they remain below levels seen in past recessions, reflecting the current strength of U.S. businesses.
4. Financial Conditions: Tightening financial conditions, driven by higher real interest rates and a stronger U.S. dollar, have implications for economic growth. The Institute for Supply Management Manufacturing Purchasing Managers’ Index (Manufacturing PMI) is in contraction territory but may be bottoming. The key question is whether easing financial conditions will lead to further interest rate hikes.
5. Corporate Credit Growth: The growth in corporate credit is a crucial precursor to a recession, and the current data indicates a relatively benign picture.
6. Bank Lending Standards: Banks are tightening lending standards, a common practice before recessions as concerns grow about creditors during economic slowdowns. This tightening is particularly evident in lending standards for large- and medium-sized businesses.
7. Consumer Sentiment: Consumer sentiment has faced headwinds from higher gas and food prices and elevated costs in the Consumer Price Index (CPI). Recent moderation in inflation could provide some relief, but the resilience of the U.S. consumer is essential to monitor.
8. Job Market: The U.S. job market remains robust, with an unemployment rate at 3.8%. The challenge is whether the Federal Reserve can restore inflation to a more reasonable level without increasing the unemployment rate.
9. Housing Market: Housing indicators, such as the decline in authorized housing units, may signal a slowdown, although the housing market still appears relatively sound.

Outlook: A Mild, Brief Recession

In summary, while most economic indicators are not currently signaling an impending recession, some negative signals and cautionary notes exist. However, taking into account the lagged effects of tightening, a mild recession in early 2024 appears plausible.

As investors and financial advisors, it’s crucial to remain vigilant and adaptable in the face of economic uncertainties. The ever-evolving economic landscape necessitates a proactive approach, allowing us to navigate potential challenges while seizing opportunities for growth and stability. While a mild recession might be on the horizon, a well-informed strategy can help weather the storm and emerge stronger on the other side.