Our team of strategists and economists have provided an update on the 6 major economic indicators they monitor to assess the risks of recession by outlining the current position and recent movement of each. These are important factor in our investment strategy and the positioning of client portfolios as we aim to balance current market dynamics and expectations for the next 6 - 12 months.
The table below is RBC Wealth Management's U.S. economic recession scorecard using the 6 key indicators, followed by a brief description of each indicator's current status.
Yield Curve
The 1-year U.S. Treasury yield moved above the 10-year U.S. Treasury yield in August 2019, creating an inverted yield curve. An inverted curve is often a leading indicator to a recession, suggesting the potential onset in mid-2020. The cause of the inversion was not typical, however, as negative yields in Europe and Japan increased demand for longer-term U.S. Treasuries and pushed prices higher/yields lower.
Unemployment Insurance Claims
Another leading indicator, unemployment claims typically bottom 6 - 12 months ahead of a recession's onset. The current trend remains downward, however, the lowest weekly reading since 2007 was in April of this year and the current GM strike will create some temporary spikes in claims. This should be monitored over the coming few months.
Unemployment Rate
An unemployment rate that begins to trend higher will usually indicate 2 - 6 months from the start of a recession. The current unemployment rate is essentially at its lowest level in almost 50 years, leaving the potential for it to move higher almost inevitable. However, with estimates of unfilled jobs in the U.S. continually higher than the number of unemployed, the move higher is likely not imminent.
Conference Board Leading Economic Index (LEI)
The most complex of the indicators as it is a calculation using dynamic weighting of 10 monthly economic variables, a recession has always followed an LEI value that falls below its prior year value. It would take 2 - 3 months of weakening data to push the year-over-year change into negative territory.
ISM Manufacturing Index
This index has been a poor leading indicator of the onset of a recession, occasionally registering a false positive. However, 2 components of the index do have a good track record of signaling recession. New orders less inventories falling below zero often occurs near the start of most U.S. recessions. Current levels are important to monitor.
Fed Fund Rate vs. Nominal GDP Growth
Since the inception of the fed funds rate in the early 1950's, a U.S. recession has never NOT been preceded by the funds rate rising above the year-over-year nominal growth rate of the economy (GDP adjusted for inflation). Nominal GDP in Q2 2019 was about 4% while the fed funds rate is at 2%. It appears that borrowing rates are showing no signs of choking off growth in the economy anytime soon.
The recession scorecard provides us with critical information relating to the broader economy and it is crucial to how we manage client portfolios in terms of asset allocation, defensive positioning, and quality biases of our security selection.
The full report from our Portfolio Advisory Committee is available here.