Amid a swirl of economic data and market turmoil over the past several months, forecasts of a recession have gained traction again. While several of these leading economic indicators are eerily accurate, it’s crucial to approach them with caution. Below we explore several of these predictors and contend why the situation might not be as dire as some suggest.
The Yield Curve:
The yield curve inversion that began in July of 2022 ignited nationwide concern. For good reason, as it has been a reliable recession predictor since WWII and we are in the midst of the longest inversion on record. However, the variability around timing is problematic. Some might recommend looking for the normalization of the curve as a more accurate predictor of pending recessions. Going back to 1970, four out of the six instances have seen the curve normalize prior to the recession with much less variability. While we’re not there yet, it appears that we are close.
Labor Market Signals:
The unemployment rate in July rose to 4.3%, up from 3.4% recorded in April 2023. This sparked renewed expectations of monetary easing. Whether it’s the Sahm Rule, the 0.5% rule, or any other employment calculation; periods of rising unemployment rates are an established leading indicator of recessions. The below charts highlight both the rising unemployment rate as well as the annual % change in weekly hours worked, both illustrating a slowdown in economic activity.
The Housing Market Conundrum:
The housing market is struggling to find balance. One of the main reasons is that the average interest rate on existing mortgages is 4.1% causing many homeowners to stay put, considering that current mortgage rates are hovering around 6.50%. This reduces available-for-sale inventory and housing turnover.
Existing Home Sales have reached levels not seen since the Great Recession:
Even construction of new homes have come down in recent months. New single family housing starts for July were 851,000 (annualized), -14.8% year-over-year and have trended lower for most of 2024:
The Fed and Fiscal Readiness:
Amidst all this talk of slowing economic activity, the Fed now appears better positioned to respond than it has in years. With a current Fed Funds Rate of 5.25%-5.50%, there is ample room to cut interest rates. Simultaneously, the FED has reduced its balance sheet by almost $2 trillion, increasing its capacity to boost money supply (QE). Fiscally, the COVID response showed the government’s capacity to mitigate economic pain through stimulus checks and liquidity backstops. While these tools were intended for the Pandemic response, it remains to be seen whether they will be considered as a viable option to help ease the impact of another recession.
Conclusion:
While recession indicators are worth noting, recessions are notoriously hard to predict in timing and complexion. The truth is nobody knows what the future will hold, whether we will have a recession, how severe will the recession be, how equity and bond markets will behave, what the monetary or fiscal policy responses will look like and how effective they might be. Investors are better off revisiting their current allocation to make long-term strategic adjustments that account for volatility, involve risk management tools, and align with their overall risk tolerances and goals. The goal is to make strategic, logical decisions during calm markets, in order to avoid making erratic, emotional decisions during tumultuous markets.
Sources:
Federal Reserve Bank of St. Louis. (n.d.). FRED Economic Data. St. Louis FRED Economic Database. https://www.stlouisfed.org/
Federal Housing Finance Agency. (n.d.). NMDB Aggregate Statistics. https://www.fhfa.gov/data/dashboard/nmdb-aggregate-statistics
Trading Economics. (n.d.). United States Existing Home Sales. Retrieved August 28, 2024, from https://tradingeconomics.com/united-states/existing-home-sales
Morrow, D. (2024, August 27). Why Home Sales Are Rising Faster in Some Cities Than Others. Yahoo Finance. https://finance.yahoo.com/news/why-home-sales-rising-faster-210049131.html
Disclosures:
This content has been prepared for informational purposes only and should not be considered as investment, tax, or legal advice. We recommend all investors to consult with a financial and/or tax advisor regarding their individual circumstances before taking investment decisions.
Investing in bonds exposes the investor to the risk of loss of principal. Lower and non-rated securities are more volatile and less liquid than investment grade bonds.
Please visit our website for a complete list of disclosures and risks: www.maustininvestments.com.
Comments