Identifying the beginning of an economic downturn often requires the benefit of hindsight, yet historical trends have revealed several key markers associated with the initial stages of a recession. This is represented below by RBC Wealth Management's U.S. Recession Scorecard, which evaluates seven pivotal economic indicators.

As the chart displays, most indicators have tilted away from ‘Expansionary’ and into a ‘Neutral’ or ‘Recessionary’ zone. That being said, expectations and calls for a recession were made as early as July 2022, yet the economy has remained resilient. With the most recent real Q3 GDP print of 4.9%, the economy seems far from falling into a recession. To get a better sense of when the economy could turn lower, RBC Wealth Management notes three additional coincident indicators. Recognizing these indicators can help investors to strategically manage their portfolio during the initial phases of a recession.

The Dynamics of the U.S. Treasury Yield Curve

Much has been written regarding the predictive value of inverted yield curves. Traditionally, a recession is forecasted when short-term yields surpass long-term yields.  We call the yield curve “inverted” because it is not “normal” for short term bonds to pay more interest than a long term bond. This represents the need for investors to be compensated more today as economic risks may be front loaded in the short term. On the other side of the coin, a “re-steepening” of the curve occurs when the yield advantage of short term bonds over long term bonds is reduced or disappears. Investors should note that it is the “re-steepening” of the yield curve that can provide better cues towards the imminency of a recession.  The yield curve could re-steepen for different reasons. If short term yields fall, this could imply that the government may lower interest rates to boost an economy that has a need for stimulus. The yield curve could also re-steepen by having long term yields rise. This could imply that economic and inflation risks may be extending further out and therefore longer term bonds require further compensation. A re-steepening due to a drop in short term interest rates is inherently more “bullish” for investors. Regardless of the reason of the re-steepening, history has shown re-steepening to be a sign that a recession was imminent. Currently, the yield curve has commenced a re-steepening process, yet still remains inverted.

The Labor Market Scenario

Another coincident recessionary indicator is the emergence of increased job losses over a three-month period. This can be measured by monitoring the U.S. non-farm payrolls, with the imminency of recession being signaled when the indicator falls into negative territory. Presently, the U.S. labor market remains robust, supported by sustained job openings and a healthy pace of employment growth.  The three-month average of non-farm payrolls has fallen from its record highs, but is still at an extremely healthy +266,000 jobs. However, with many companies announcing a second round of layoffs, investors should monitor this indicator carefully for any sustained weakness.

Consumer Confidence Trends

Lastly, consumer confidence trends can also help predict the timing of a recession. One would look for a deterioration in consumers' perception of the current economic state relative to their expectations over the next six months. Although this indicator is sentiment-based and influenced by human emotion, it has historically proven to be a reliable gauge. The current chart shows that consumers feel confident about present conditions and therefore it does not signal an imminent recession. Investors should keep an eye on the blue line and should it turn higher, it would imply that consumers feel worse today and more likely to step into a recession.

As of now, none of the three coincident indicators suggest an imminent U.S. recession. Thus far, the economy has impressively kept a recession away despite a punishing flurry of interest hikes, a multitude of geopolitical stresses, elevated price pressures for consumers and a fragile global economy. Although we feel the economy is still on track for a “soft landing”, careful monitoring remains crucial. Any trigger or combination of the above factors may signify a substantial increase in recession risks, warranting a more defensive approach in portfolio management.