Watching For Recession

Recent anxiety about an imminent recession sparked discussion of inverted yield curves and falling long term interest rates, The slope of the yield curve – the difference between the yield on the five or 10 year treasury note and a short term instrument like three month T-bills – may signal a recession. The chart shows the slope of the yield curve and recession dates since April 1953. The slope moved below zero as each recession began.

The idea of using the yield curve to predict the economy has a long history. Other combinations of treasury notes and bills show the same patterns; the choice of five or ten year notes and three-month bills gives the longest data history. There is some theoretical backing: when consumers and investors fear a recession is coming, they are likely to move assets into intermediate and long-term bonds as a hedge against future economic difficulties. This asset re-allocation may raise bond prices, lower yields and dampen the stock market. (See “Forecasts of Economic Growth from the Bond and Stock Markets” by Campbell Harvey, Financial Analysts Journal, September-October 1989)

While the first chart suggests that the yield curve is a useful predictor, the next chart shows that the stock market gives less accurate predictions. The market moves associated with the recessions in 2000-2001 and 1990-1991 were largely after the recessions. The economy kept on rolling despite the 1987 market crash.

The financial markets are not the only thing driving the economy – changes in employment matters.  The last chart shows the weekly Initial Unemployment Claims series published by the Bureau of Labor Statistics. When economic activity begins to fade companies respond by cutting hiring and letting people go. Jobs-losers file for unemployment. A rule of thumb is an initial claims number above 400,000 is cause for concern while a figure under 300,000 signals an unusually strong economy.

With all these, what is the risk of a recession near term? Initial claims suggest there is little to worry about while the yield curve signals some caution.

The posts on this blog are opinions, not advice. Please read our disclaimers.

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