Are we already in a recession?

The sad truth about recessions is that you could already be in one and not know it.

The most commonly agreed-upon definition of a recession is two consecutive readings of negative growth of a country’s gross domestic product. Considering that these readings are conducted quarterly, the economy could have been contracting for quite a while before it becomes “official.”

You don’t have to go back too far in history to see the perfect example. On December 1, 2008, the National Bureau of Economic Research – the non-profit institution which serves as the arbiter of such things in the U.S. – declared that the country was in a recession. It noted that the recession began in December 2007, a full year earlier. You would think that the doubling of the unemployment rate, the bankruptcies of Bear Stearns and Lehman Brothers, the near-nationalization of the auto industry, and the 40% drop in the Dow Jones Industrial Average would have provided some kind of heads-up.

But two straight quarters of shrinking GDP isn’t the only definition of recession. Maybe, by some other measure, we have already passed the cusp into a new – and less benign – economic era.

Maybe so

GDP is a less-than-perfect indicator of how the average person experiences the economy. As noted below in the market overview, the most recently ended quarter’s GDP reading was adjusted down because of slow exports and a bump in inventories, neither of which is going to make too many families cancel vacation plans.

Most people don’t feel a recessionary experience until they or people close to them are out of work. If there is an early-warning system for that, it’s hiring freezes. Companies tend to stop building staff well before they start cutting it. So far, that hasn’t been happening in a significant way. American firms added 130,000 new jobs in August – lower than expected, but still not a bad read. By almost every metric the Labor Department can throw at the count – employment-to-population ratio, unemployment rate, individuals not in the labor force – the numbers just keep getting better.

The key word is “almost.” There are some dark clouds. The number of people who can only find part-time work is growing, as are the number of discouraged workers leaving the work force. But the most interesting tea leaves to read have to do with workers’ reasons for unemployment. More people are losing their jobs, and fewer people are leaving them.

LinkedIn, 1930s-style Credit: Virginia Commonwealth University

Ironically, Uber – the company that practically invented the gig economy – is the only major private-sector employer that recently announced a hiring freeze. If more follow, that would be a recessionary signal.

It is also important to note that there’s no such thing as “the” economy. The U.S. is a well-developed nation in terms of its financial health. It has many interdependent but distinct components: manufacturing, services, finance, farming, and the public sector. Taken together, it all looks fairly healthy today, but a closer look reveals that not everyone is experiencing the current expansion equally.

It’s easy to forget that manufacturing is not doing particularly well at the moment. Factory output dropped 1.2% in the second quarter, according to the Federal Reserve, following a 1.9% drop in the first quarter, as capacity utilization languishes below 78%. Fed Chairman Jay Powell cited this as the reason for the recent Fed funds rate cut, and MarketWatch quotes one leading economist as saying the manufacturing sector is in de facto recession.

Maybe not

First, let’s get one thing out of the way: The yield curve inversion you’ve read so much about is not an accurate predictor that a recession is imminent. A analyst told Forbes that there’s generally a two-year lag from flash to bang.

To restate, hopefully for the last time, an inverted yield curve “suggests that investors favor short-term rather than long-term investments, indicating a likely lack of confidence that the economy will keep growing at the present pace.” That was written in April about an event that occurred in March. Half a year later, GDP is still gaining.

But the yield on the 10-year Treasury note dipped below that of the 2-year again in August and once more people got a little skittish. After all, a yield curve inversion has presaged every U.S. recession since 1955.

When the 10-year Treasury note yield is lower than the 2-year yield, it creates an inverted yield curve. The last five out of seven inverted yield curves have led to recessions.

That said, yield curve inversions are not all created equal. It is a matter of longevity, and it is a matter of degree. The March 2019 inversion was essentially a blip. The one last month didn’t last much longer. As of this writing shortly after Labor Day, the 10-year note is once again offering a higher yield than its shorter-term counterpart.

Also, let’s not forget that there are more Treasury instruments than just the 10- and 2-year notes. Those are just the arbitrary “benchmarks,” and that’s not even the comparison the Federal Reserve looks at; the central bank pays far more attention to the spread between the 10-year note and the three-month bond. Foreign exchange traders prefer to contrast the 10-year note yield with the Fed funds rate. But however you slice it, no two points indicate a trend. Of course, once the 3-month – or for that matter the 1-month – bill’s yield is higher than the 30-year bond’s, then the time for panic has already come and gone. Somewhere along the path to that nightmare scenario is the right moment to switch to playing defense.

Also, let’s remember that the worst inversion of this past half year was a negative 5-basis point spread between the 10- and 2-year bonds. That might have been the worst since 2007, but it’s hardly the worst of all time. In the “stagflation” days of the 1979 recession it dropped to the 200-basis point neighborhood.

Former Fed chair Janet Yellen, for one, has stated that there might be more noise than signal coming out of this warning beacon.

“On this occasion, it might be a less good signal,” she told Fox Business News. “There are a number of factors beyond market expectations about the future path of interest rates that are pushing down long-term yields.”

She has a point. Just because every recession in living memory was preceded by an inverted yield curve, that doesn’t mean that every inverted yield curve in living memory preceded a recession. Yield curves inverted in 1966 and again in 1998, and the good times kept rolling. Thus, this indicator has accurately predicted five of the last seven recessions.

But that analyst, Greg McBride, had one more thing to tell Forbes: “The most dangerous words in finance are ‘it’s different this time.’”


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