Recession Watch

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: August 26, 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 in our office’s NBER 4 pack of charts. 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 June 2022 the probability the U.S. had entered into a recession was 1.7% 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 is giving a clear red light signal. The only times in the historical data the index has declined as much as it has lately 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. In June 2022, 10 of the 11 individual indicators declined. Only housing permits ticked up, but are generally bouncing around a steady trend. Which brings me to the other hand. Most of these indicators are not plunging, they are more steady to slowing. The math just works in such a way that the June data do show the steep plunge. Furthermore many of the indicators that are down have key qualifiers to talk about. Like yes consumer sentiment is very low, but consumers keep spending, and job openings are declining, but the Federal Reserve is explicitly trying to bring job openings down by wringing some of the excess demand from the economy, etc. Given all of this, I expect the July and August data to not deteriorate too much further, and maybe even begin to look a bit better moving forward, but of course time will tell. And economists always need to be careful explaining away issues and saying that this time is different. Our office is in the process of developing the next forecast and meeting with our advisory groups. That forecast will be released at the end of the month — Wednesday, August 31st. We will have more to say at that time.

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. The data is not seasonally-adjusted so the recent uptick earlier this summer is part of the normal seasonal pattern and not yet noteworthy by itself. The Federal Reserve has explicitly said they would like to see better balance in the labor market, including job openings declining off their record highs. Part of this better balance may be slightly higher levels of initial claims.

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. Right now the yield curve is inverted. Short-term interest rates are high — and need to be high because the Fed is raising rates to cool the economy and slow inflation. However longer-term interest rates aren’t increasing as well because they are broadly anchored to longer-term economic growth conditions. We know that future labor force growth is weak at best, and productivity gains have been mediocre for decades, and markets believe that no matter what the Federal Reserve will bring inflation down to target in the future. All of that means longer-term interest rates are generally anchored around 3% or so. As such, it does mean the yield curve is inverted. 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).

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