Recession indicators are vibrating in the US

The recession in the US has been on the way for a long time. The American consumer has withstood high interest rates thus far, and the slowdown in job growth is mainly a positive sign, as it means overdemand has decreased and the labor market is seeking a balance after heating up. However, according to most recession indicators, the economic downturn still lies ahead. In this article, I will discuss the key recession indicators. 

1) Reversal of the interest rate curve followed by a U-turn. Typically, the reversal of the interest rate curve has been an almost foolproof recession indicator. But the recession is even closer if the interest rate curve steepens again after turning negative, that is, the difference between short and long-term interest rates decreases. However, the weakness of the indicator is that the start of the recession after the U-turn is on a broad scale: In the past, the timeline has been 3-21 months.

2) The Sahm rule for the unemployment rate.  I wrote in my macro review yesterday how the unemployment rate in the US rose to its two-year peak of 3.9% in October. At the same time, the three-month moving average of the unemployment rate is close to exceeding the bottom of the cycle by 0.5%. When this occurs, it would, according to the Sahm rule, mean the beginning of a recession. The rule was developed by Claudia Sahm, a former economist of the Federal Reserve and current Bloomberg columnist, and as you can see from the figure below, it has held true in previous recessions.

3) A decline in the Leading Economic Indicators index. As the figure below shows, the Leading Economic Indicators index of the US has almost always dropped before the start of a recession, and now the drop has been steepish. The index published by the Conference Board this time peaked in February 2022, so it has been falling already for 20 months. Reuters said the average delay is 14 months and the longest was 22 months just before the financial crisis. According to this indicator, we are in an exceptionally long cycle.

4) The ISM Manufacturing index dropping below 45. The ISM Manufacturing index has also been considered a recession signal when it falls below 45. This has not yet been achieved, but we are close to the recession signal. However, I do not assign this indicator too much of a foreteller role as the US economy is currently focused on services.

5)Recession probability. The recession probability issued by the Federal Reserve Bank of New York can be seen as a softer computational indicator, which typically rises before a recession. As you can see from the figure below, the probability is now at a high level even historically. It is, therefore, no wonder that economic talk refers to the most anticipated recession in the world.

In a rough interpretation, 3/5 of the indicators I mentioned predict that the US is already in a recession and the remaining two that it is near. It is also known that the housing market will stagnate first, and employment will fall long after when the economic cycle turns, so strong employment data does not always give an accurate picture of the actual state of the economy. Economic figures are, however, still on the right side, so if we sink into recession, it would be short and moderate. The realization of the recession scenario would also be good news, as it would accelerate the drop of interest rates from current peak levels.