Oregon Office of Economic Analysis

The economy is in an inflationary boom. Jobs, income, and production are all increasing quickly. However the ongoing bout of inflation — the fastest in 40 years — has pessimism about the expansion growing and is eroding some of those gains. The Federal Reserve is communicating they will raise rates higher and faster than previously expected to cool demand and slow inflation. Given inflationary booms traditionally don’t end well, economists are on recession watch. Historically Oregon’s recessions and expansions are perfectly aligned with the nation’s in terms of timing. That said, Oregon is usually more volatile than the nation with more severe recessions and stronger recoveries. Below our office will regularly update some important measures of economic activity. These updates are likely to be monthly and near the end of the month.

Most Recent Update: October 25, 2022

NBER Recession Dating

The National Bureau of Economic Research is the official arbiter of US recessions. The NBER defines a recession as a significant decline in economic activity that lasts more than a few months. Key data the NBER uses to date recessions and expansions includes: employment, industrial production, real personal income excluding transfer payments, real personal consumer expenditures, and real wholesale-retail sales. The latest data are shown below, expressed as percent change since the start of 2021. The latest data show that jobs and industrial production continue grow. Incomes and spending are increasing quickly too but struggling to keep up with inflation. As of this summer, it is unlikely the U.S. has entered into a recession.

Recession Probability

As of August 2022 the probability the U.S. had entered into a recession was 1.2% according to the latest update from Jeremy Piger, an economics professor at the University of Oregon. Professor Piger’s model uses the NBER variables above in a dynamic-factor Markov-switching model to estimate the probability the economy has switched from an expansion to a recession or vice versus. Three consecutive months above an 80% probability have historically been an accurate signal of the onset of recession.

Oregon Index of Leading Indicators

Our office developed the Oregon Index of Leading Indicators (OILI) following the dotcom recession back in the early 2000s. The index is best thought of as a red light/green light measure that leads the overall economy by 6-12 months.

To be honest, right now is really challenging. On one hand the index has given a clear red light signal. In September 2022, 8 of the 11 individual indicators declined, while 3 of the 11 individual indicators increased. This is a slight improvement from June when only 1 of the 11 increased. Even so, the only times in the historical data the index has declined as much as it has this year was during the Asian Financial Crisis (not a recession, but a period of weak growth in Oregon), the dotcom recession, the Great Recession, and the COVID recession. The economy has typically already been in recession when the index declines like this.

Overall the challenge is how much of these declines represent fundamental economic weakness pointing towards a true recession versus a slowing off of the pandemic and reopening highs. For instance, job openings are declining but the Federal Reserve is actively trying to bring labor demand (openings) back down to existing supply (number of available workers). However job openings would also decline in a recession. Conversely, while actual industrial production continues to increase, propping up the index and the economy, other goods-related indicators like purchasing managers index, the strong dollar, and housing permits that are starting to decline due to high interest rates point toward an overall slowdown coming in goods activity, which will also slow the overall economy. The combination of everything certainly does not look good. Even so it’s important to keep in mind the initial path for the economy that ends in the soft landing looks very similar to the path that leads to a recession as well. It is not outside the realm of possibilities that the economy skirts a recession, even if it’s harder to make that your most likely forecast today.

Our office’s next forecast will be released Wednesday, November 16th.

Initial Claims for Unemployment Insurance

In terms of individual indicators, two stand out in terms of accurately predicting recession. The first are initial claims for unemployment insurance. These are predominantly a measure of real-time layoffs in the economy, but also contains some information on worker behavior and how quickly a newly laid off worker expects they will be able to find another job. Right now initial claims are at or near record lows, meaning it is unlikely the economy will soon start to shed jobs. This is a key measure to watch for the future state of the labor market. And to the extent that the Fed’s vision proves accurate, the labor market balance would come more from declining job openings and not necessarily more laid off workers.

Yield Curve

The second individual indicator is the yield curve. The yield curve inverts when financial markets price short-term interest rates higher than long-term interest rates. This indicates financial markets expect the Federal Reserve to cut interest rates in a recession in the future and therefore longer-term rates are lower than short-term rates which are still high given current economic activity and inflation. An inverted yield curve is typically a signal of economic growth concerns and for the Fed to tread carefully on policy to not send the economy into recession in the future. The yield curve tends to be a long leading indicator, usually in the 12-24 month time frame. Right now the yield curve has been inverted since July.

Short-term interest rates are high — and need to be high because the Fed is raising rates to cool the economy and slow inflation. To uninvert the yield curve we would need to see inflation come down, and therefore short-term interest rates decrease (would happen in a soft landing scenario, or a recession), and/or longer-term interest rates to increase due to more optimism about future growth (the better outcome, but probably harder to see given recent history and projections).