The next recession is coming, according to most economists. They're just not sure when.
While 38% of economists expect a recession by the end of 2020, another 34% don't see that happening until sometime in 2021, according to the results of an August survey by the National Association for Business Economics.
Those results may not reflect economists' most current outlook, though, since NABE conducted its survey before the market's recent bout of bumpiness. For the fourth time in recent weeks, the yield on the 10-year Treasury note fell below the two-year rate on Friday. This phenomenon has returned for the first time since December 2005, rattling traders — and for good reason: It's been a reliable indicator of recessions in the past.
Uncertainty surrounding the possible economic impact of the drawn out U.S.-China trade war has stoked fears about a slowdown: Goldman Sachs warned that President Trump's newest round of tariffs could trigger a recession. Traders are also wondering whether the Federal Reserve, which cut interest rates in July for the first time since the Great Recession, will be able to extend the current economic expansion, though Fed Chair Jerome Powell has promised it will.
Still, predicting the next recession is difficult, even for the pros. Some of them have been predicting a recession for years, and yet the expansion has continued. Five years ago, about 40% of economists thought there was at least a 10% chance the economy would enter a recession within two years — and of course it never did.
Here are three signs of a possible recession that professional investors monitor — and what they're signaling now:
The bond market recently flashed a warning signal about a possible recession. The so-called yield curve measures the difference in interest rates for two bonds with different maturity dates. You can plot the yield curve for two Treasurys of any duration, but some of the most-tracked are:
- The 10-year Treasury yield versus the three-month Treasury yield
- The 10-year Treasury yield versus the two-year Treasury yield
When the economy is expanding, the yield curve slopes upward because investors are optimistic about the potential for growth in the future, so the interest rate on long-term bonds is higher than that on short-term bonds. But if investors see the risk of an economic slowdown or recession in the near future, they'll require higher returns to invest in short-term bonds.
When the yield on longer-term Treasurys is lower than the yield on shorter-term Treasurys — creating what's known as an inverted yield curve — it shows investors see the risk of a slowdown ahead. Earlier this year, the 10-year Treasury yield first dipped below that of the three-month Treasury yield. Based on the current spread, the Federal Reserve Bank of New York puts the odds of a recession by July 2020 at about 31%.
The spread between the 10-year Treasury yield and the three-month Treasury yield has "the strongest predictive power," and an inversion has preceded every U.S. recession in the past 60 years, according to research from the Federal Reserve Bank of San Francisco.
But market participants more closely track the spread between the 10-year and two-year yields — and this yield curve has now inverted multiple times. There have been five similar inversions since 1978 and each one preceded a recession by an average of 22 months, according to data from Credit Suisse.
Is this indicator making experts worry: Yes
The unemployment rate has a perfect track record for predicting recessions, according to Natixis. And when there's a rapid spike in unemployment — particularly a 0.5 percentage point increase in the jobless rate from a prior 12-month low — "the economy is effectively always in a recession," according to research from The Brookings Institution.
In April, the jobless rate fell to 3.6%, the lowest level since 1969. If this remains the low, the above model suggests the U.S. economy will be in a recession once the unemployment rate rate reaches 4.1%.
As of July, the unemployment rate is just 3.7%, far from the threshold that might signal a recession.
Is this indicator making experts worry: No
Of the three recession indicators that pros tend to watch, the stock market is the least reliable. "You'll often see a bear market and a recession happening at the same time, but not always," Caleb Silver, the editor-in-chief of Investopedia.com, recently told Grow. (Check out the video above for his tips on how to distinguish between the two.)
A bear market is defined as a decline of 20% or more from a recent high for a stock index (like the S&P 500) or any other asset, including an individual stock.
Since 1945, there have been 13 bear markets in the S&P 500, and eight of them overlapped with some part of a recession. That means bear markets have been a recession indicator almost 62% of the time. Based on closing levels, the S&P 500 hasn't experienced a bear market since the 2007-2009 crash that accompanied the Great Recession. And the U.S. economy is in the midst of its longest-ever expansion, which is currently more than 10 years old.
While the market's recent choppiness saw the S&P 500 fall as much as 6.1% at its worst, that's still far from bear market territory.
Is this indicator making experts worry: Not really
From the yield curve to unemployment to the stock market, the historically reliable recession indicators are, at best, mixed. And based on six indicators tracked by Credit Suisse, the U.S. economy is nowhere near a recession. So, though a slowdown is inevitable at some point, it may not be as soon as some people fear.
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