The bond market has been pressuring the Federal Reserve to cut interest rates in response to what many believe is a steadily weakening economy. Recession seems to be on the minds of analysts as the yield curve inverts and yields fall to levels last seen in 2016. So, just what do economists mean when they say the economy is in recession? What are the markers that characterize this condition?
The National Bureau of Economic Research (NBER) sets the standard when it declares that “a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators. A recession begins when the economy reaches a peak of activity and ends when the economy reaches its trough.”
Even this definition leaves a lot to be desired for it remains vague as to duration. Thus, many consider that two consecutive quarters of economic decline qualifies to be called a “recession”.However, by the time government data is collected and released and the NBER does its calculations it might be six months after the recession actually got started. In essence, we would be looking at the world through a rear-view mirror, rather than watching the road ahead.
While waiting for the “official” word whether a recession has started, let's look at how the data has changed from the March FOMC meeting to the latest results (May)[1]:
* Inflation is decelerating and moving farther way from the 2% target set by the Fed; in March, the PCE was running at 1.9% by May the rate fell to 1.5%; inflation expectations, as measured by the 5yr/5yr forward rate, have dropped from 2% to 1.85% during the same period;
* the 10-year bond yield has fallen from 2.6% in March to 2.1 % today, and now the entire yield curve is below the Fed funds rate; an inverted yield has been a reliable harbinger of recessions in the past;
*Average earnings and hours worked are falling; average hourly earnings in May were growing at 3.1%, compared to 3.4% in March; despite the lowest unemployment record in decades, earnings are nowhere near what would be expected in a tight labor market;
* Commodity prices are under pressure; oil has fallen from its most recent peak of $66 set in early May to $52 today, as the oil market braces itself for weak demand worldwide; agricultural prices are slumping badly in the wake of Chinese tariffs on US staples such as soybeans, pork, and corn;
* US tariff policy is starting to literally hit home, as a wide variety of suppliers are faced with lower profits and /or higher sale prices; both intermediate and final demand goods are bearing the brunt of this trade war;
*financial conditions are tightening, especially for small and medium businesses, as bankers are more cautious in advancing loans;
* business sentiment, as measured by ISM’s manufacturing index, has turned south and now sits at the lowest level since 2016; this is translating into declines in business capital expenditures, eventually leading to a slowdown in hiring; and,
* GDP (tracking) now anticipates that output will grow at just 1.6%, compared to estimates made in March which called for growth to hit 1.9% for the year;
Worldwide interest rates have peaked, and in some cases, central bankers have already reversed course and began to cut rates, most noticeably Australia. Wall St forecasts have ranged anywhere from one to three 1/4pt cuts in the Fed funds rate before year’s end. Central bankers do not have the luxury of waiting until the NBER announces that a recession has set in. There is plenty of evidence to argue that the US is already in the beginning stages.
[1] See chart in Goldman: Here's Why The Fed Is About To Shock The Market
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