How Do You Know When a Recession Is Coming
It looks like everyone is using the dreaded R word this week – recession as the stock market looks upside down, bond yields are falling and the trade war is dragging on. But these events do not mean that there will be a recession tomorrow. It may not even take place next month, in the next six months, or even next year.
There are several signs of an economic downturn, which together could indicate an impending recession.
The yield curve is inverting
When interest rates on short-term government bonds exceed interest rates on long-term government bonds, economists say the yield curve has inverted. This is a sign of pessimism among investors and a reliable forecast of an economic downturn. In fact, the last five recessions were preceded by an inversion of the yield curve, although this does not mean that the recession will happen immediately.
It is also worth noting that since there are several different lengths of government bonds, the yield curve can be inverted more than once. The 3-month Treasury yield curve inverted with the 10-year Treasury yield in March for the first time since 2007. Then, on Aug. 14, the yield on the 2-year Treasury bonds flipped with the yield on the 10-year Treasury bonds. This last happened in 2007, although it changed briefly at the end of 2005, two years before the start of the last recession.
The unemployment rate is rising
In a downturn, there is a trickle-down effect: people stop spending money, which means that things are worse for businesses. Companies are laying off some of their employees. If many businesses are engaged in this at the same time, it will be more difficult for laid-off people to find a new job. If the unemployment rate rises, it is a signal that things are not going well.
We still have a very low unemployment rate. By comparison, at the end of the last recession in 2009,the unemployment rate fluctuated between 8 and 10%. Since then, it has been declining and since January 2019 it has been less than 4%.
But ongoing trade negotiations with China could have a long-term impact on employment. Many US businesses that rely on China for equipment, parts or manufacturing services are nervous about the impact of additional tariffs on their ability to profit and continue to expand. President Trump said he would postpone the introduction of a new round of tariffs until mid-December so that retailers do not have to raise prices during the crucial holiday shopping season.
GDP falls
In short, gross domestic product (GDP) is the size of the economy . It is often calculated by looking at consumer spending, business investment, and exports. If that combined figure drops significantly, that’s bad news.
GDP is measured on a quarterly basis, and although it has rebounded a bit lately, it has not fallen as we saw during the last recession.
The consumer spending portion of GDP is a little annoying, because if enough people get nervous about the recession and start hoarding money under the mattress instead of shopping, that measure will diminish, leading to a decline in overall GDP. This does not mean that you and I alone will be responsible for the next recession, but that the frequency with which a recession is discussed may affect our path to it.
Stock market tanks
When the stock market drops rapidly — for example, when you see a headline about “the worst day of the year,” or something similarly bleak and sad — it’s because many investors are unsure about the economy and are selling as many shares. as they can. If the stock market falls over and over again almost daily, it is a sign of trouble.
But the stock market is doing well overall. Take the Dow Jones Industrial, for example: it fell sharply at the very end of 2018 but recovered. This is still a roller coaster of sorts , but we are at a more comfortable level than the stock market during its recovery 10 years ago.
Don’t Fear the Next Great Recession
A slowdown in the economy does not mean that we will automatically fall into the next Great Recession. It was … well, it was a big cluster, the worst economic downturn since the Great Depression, and a bad crash after years of intense economic growth.
A recession is simply a period of economic downturn that lasts six months or more. Typically, a recession occurs every six or seven years, as the best economic periods are more or less balanced with the bad ones. While the Great Recession of 2007-2009 and its aftermath are the highlights, 2001 also saw the dot-com crash (yes, that was part of the recession). There was also a recession in July 1990, around the same time as the first Gulf War. Sometimes we forget about these economic periods because our last recession was very painful, with a long recovery period.
And to add another complication to all this, the National Bureau of Economic Research, which points to recessions and their duration, is doing it in hindsight. (The Great Recession was not named until November 2008, although it actually began in December 2007). So, there is no way to know for sure that there will be a recession until you get into it.
Your best bet is to sit back, manage your finances, and hope for the best news from economists.
This post was originally published on 8/15/19 and updated on 8/15/19 to include clarified language on bond yields.