Will The U.S. See A Recession? Key Metrics Offer Divergent Takes

An inverted yield curve has among the best track records in forecasting recessions in the U.S. post-war period. The U.S. yield curve is currently deeply inverted and has been for some time, that’s a sign a recession’s on the way. However, the jobs market disagrees. The U.S. is adding jobs, as of the January report, and unemployment is historically low. Given the consumer is the majority of the U.S. economy, it’s fairly unlikely for the U.S. to see a recession when employment is rising. So will we see a recession in 2023 or won’t we?

The Yield Curve

The New York Federal Reserve currently estimates the probability of a U.S. recession at 47% on a 12-month view as of December 2022. That’s high. Ironically it’s a greater probability than before the past 4 U.S. recessions.

There are good reasons why the yield curve should predict recessions and its historical track record is strong. However, no economic indicator is perfect, so maybe the yield curve is getting it wrong this time. Nonetheless, it’s important to remember that the yield curve is a forward-looking indicator. That means we can’t write off the yield curve’s recessionary signal just yet.

The Jobs Market

In contrast to the pessimism of the inverted yield curve, the U.S. economy added over a half a million jobs in January 2023. That’s also broadly consistent with 2022, when the economy added over 400,000 jobs each month. The growth in employment was relatively broad-based. If an economy is adding jobs consistently, then a recession is less likely, that’s because consumer spending is a major driver of economic growth and tends to increase with employment. So the jobs market doesn’t offer any real sign of recession currently.

So Could There Be a Recession?

The optimism from the jobs market and pessimism of the yield curve are not entirely contradictory. The scenario that would reconcile them is a U.S. recession later in 2023. That’s because the yield curve is a forward looking indicator, whereas the jobs market is an assessment of recent economic performance. In past economic cycles the job markets has turned quickly, with unemployment rising in just a few months as a recession emerges. Just because the jobs market is strong now doesn’t mean it couldn’t weaken on a 6 month view. However, for this to play out we would need to see the jobs data start to weaken in the coming months, clearly that’s something we haven’t seen just yet.

For example, economist Claudia Sahm estimates that the U.S. economy is in a recession when the 3-month average of the unemployment rate rises by half a percent from its 12-month low. Despite current strong jobs data, that’s still quite possible for 2023, though there are no signs of it currently and to the extent that we continue to see a string of robust jobs reports, so any chance of recession will fade.

Other Risks To The Economy

Other economic indicators are more suggestive for pessimism for the U.S. economy. The housing market, as measured by new building permits is relatively weak. Rising mortgage costs and low affordability aren’t helping the housing market either. Housing is a relatively small part of the economy, but swings in housing activity can be large, meaning that a soft housing market can contribute to a recession.

Consumer expectations are relatively negative and various business surveys are soft too. All of these suggest economic growth may be sluggish in 2023, however it’s unclear if that translates to a recession or not.

That said, there are positive indicators too, the stock market is among the best leading indicators of the economy and has generally rallied in 2023 so far. That may be a good sign, for now.

Divergence

We’re currently seeing relatively high divergence in economic indicators. The stock market and the jobs market both suggest optimism. However, other indicators with robust track records are casting a shadow, especially the yield curve. One way to reconcile this would be if a U.S. recession were to occur later in 2023. Nonetheless, the clock is ticking on that recession forecast, if the U.S. is to see a recession then we would expect some weakness in the job market in the coming months. We’re not seeing it currently. It’s also conceivable that the U.S. sees a recession as the job market holds up, perhaps based on extreme weakness in a sector such as housing or a different economic shock, but that would be historically unusual.