Given the increased volatility in the market, there has been a lot of questions about the yield curve inverting and what this means for the broad financial markets. The yield curve's inversion is appropriately perceived as a worrisome signal of U.S. recession risk, but it is worth assessing a wider spectrum of financial and economic indicators, which suggests the U.S. economy remains on a modest, albeit slow growth trajectory. Below we highlight five non-yield curve U.S. recession risk indicators.

 

1. The state of health of the corporate sector: The chart below shows U.S. corporate sector financing gap (as % of GDP), with US recessions. Elevated corporate debt levels remain a concern, but the U.S. corporate sector is generating spare free cash flow (on this measure, i.e. pre accounting for buybacks). There hasn’t been a recession since WWII without this measure being in deficit.

 

 

2. The tightness of credit conditions (corporate & household): Credit conditions remain relatively loose, i.e. the availability of bank debt remains accommodative. There has been some modest tightening of credit card and other consumer lending conditions. That tightening, though, is not sufficient enough, per se, to significantly impact consumer expenditure growth expectations. Illustrating that point, the delinquency rates for personal (consumer) loans are back at one of their lowest rates in recent decades (see chart below).

 

3. The tightness of monetary policy: This category is generating a mixed message. The yield curve has inverted. Equally real M1 money supply growth did (briefly) turn negative (last year – see chart below). This is also a good recession indicator, but again, it’s not a clear signal. When, for example, real M1 growth turned negative ahead of prior recessions, it tended to remain negative for several months, with growth contracting sharply.

 

4.  The state of financial conditions: There are no tangible signs of financial stress in the system. U.S. HY corporate bond spreads have been in a widening trend since late 2018, consistent with some modest tightening of financial conditions (although are not currently excessively wide). Overall, financial conditions are consistent with an ongoing recovery, and furthermore are likely to be aided by further central bank stimulus (rate cuts) in coming months.

 

 

5. The message of leading economic indicators: Leading economic indicators are flashing cautionary signals. When it comes to the U.S. Conference Board Leading Economic Indicators (see chart below, year-over-year change), sub-2% annual growth is a recession warning. On its latest data point (June), this indicator generated a recession warning (albeit it’s still at a similar level to 2011/12 and 2015/16, which were false recession signals in hindsight as those turned out to be mid-cycle slowdowns).

 

 

 

 

Lastly, as market volatility has escalated in August, the table below takes a look of the instances of ±1% trading days for the S&P 500 over the last few years.

 

 

 

 

 

 

 

 

 

 

 

If you'd like to discuss this further, feel free to give me a call at 416-974-4059.