While still enjoying the longest economic expansion in our nation’s history, we are seeing growing signs that a recession will soon be upon us. The only question is “When?” Economists look for three warning signals. The most complicated signal – an inversion of short-term and long-term interest rates, set off Wednesday’s huge stock market sell-off.
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Since bond investors tie up their money for relatively long periods of time – typically around ten years – they expect to earn a considerably higher interest rate than people who invest in securities that mature in no more than two or three years.
Except under very unusual circumstances, ten-year bonds do pay much higher interest rates than two- and three-year securities. But when shorter term securities provide higher yields than long-term securities – as they did earlier this week – we have what is called an inversion.
An inversion of short- and long-term interest rates is a reliable indicator of an imminent recession. It doesn’t in any way cause the recession, but an inversion is a clear sign that a recession will soon follow. Still, it does not make a recession inevitable.
A second sign of an approaching recession is a sustained rise in the unemployment rate from its cyclical low-point. During an economic expansion, such as the one we’ve enjoyed these last ten years, our monthly unemployment rate has declined quite steadily.
In April of this year, it reached a low of 3.6 percent – the lowest it has been in fifty years. It remained at 3.6 percent in May, and then rose slightly to 3.7 percent in June. Our unemployment rate remained at 3.7 percent in July.
Does that mean that 3.6 was our unemployment rate’s cyclical low-point, and that it is now on its way up again? If the answer is “yes,” then we are very likely headed into a recession later this year.
But we may not know for sure for at least another few months, as we watch to see if our unemployment rate continues to rise, and the May and June’s 3.6 percent were cyclical low points. You’ll be able to access the August unemployment rate at bls.gov at 8:30 am on September 6th.
That brings us to our third recession indicator, the Leading Economic Index, compiled monthly by the Conference Board. The index is composed of ten variables which tend to rise or fall two or three months before a rise or fall in the overall level of economic activity. These include building permits, manufacturing activity, and the rate of growth of Gross Domestic Product (adjusted for inflation).
The Index rose in March and April, was unchanged in May, and declined by 0.3 percent in June. July’s index will be available early next week at Conference-Board.org. If it declines again, that’s still another warning that a recession may be imminent.
Perhaps still more alarming than long-term interest rates is that the annual rate of growth of GDP (adjusted for inflation) fell from 3.1 percent in the first quarter of 2019 to 2.1 percent in the second quarter, and will very likely fall below 2 percent in the third quarter.
In addition, our trucking sector appears to be in a recession, auto sales have been slumping for the last year or so, industrial production is down this year, and our agricultural sector is hurting badly due to President Trump’s trade war with China. And if all that were not enough, there are other signs of the beginnings of a global recession.
By early September if the inversion has continued, the unemployment rate has risen again, and the Leading Economic Index has fallen again, then I would say that our chances of having a recession later this year are better than even.
Do you think long-term interest rates and yield curve are a good economic indicator? Or do you believe like Yellen says that its no cause for alarm? Tell us in the comments section.