In the last two weeks, if you turn on the television all the news shows are talking about the possibility of a recession. Many of them are citing the U.S.-China tariff escalation and the slowing growth in the United States as two precursors, as well as slowing economies abroad and the uncertainty of Britain’s future as it leaves the EU. All of this has led to jitters on Wall Street.
Albert Wang, the Synovus Fellow and associate professor of finance in the Auburn University Harbert College of Business, recently shared his thoughts on the possibility of a recession in the U.S. Wang researches empirical corporate finance, corporate governance, mutual funds and behavioral finance. His research has been published in the Journal of Financial Economics, Review of Financial Studies, Journal of Financial and Quantitative Analysis, Review of Corporate Financial Studies and Financial Management.
What do the financial indicators reveal?
Let’s first take a look at some financial indicators that may point to the recession. Those include gross domestic product growth, consumer spending, commodity prices, interest rates, the yield curve, unemployment data, confidence index, house prices, house sales, etc.
GDP grew 2.1 percent in the second quarter. Through July, retail sales have increased by 0.7 percent, after 0.3 percent in June. Commodity prices are growing: The oil price is up over 50 percent, and aluminum and copper are both up over 30 percent since 2016. The unemployment rate remained at an exceptionally low 3.7 percent in July. U.S. existing-home sales rose 2.5 percent in July and marked the year-over-year uptick in 17 months. All those numbers indicate the economy remains strong so far, but there are some other indicators listed below that raise some concerns.
What is the inverted yield curve and what does it indicate about the economy?
On Aug. 14, the 10-year treasury yield briefly fell below the two-year yield, prompting a wide selloff in stocks, with the Dow Jones Industrial Average falling 3 percent. An inverted yield curve, most commonly defined as the 10-year treasury minus the two-year treasury, has preceded each U.S. recession since 1955. The yield curve inversion does not explicitly indicate a recession, but is instead a predictor of interest rate cuts. Because the Federal Reserve cuts rates in response to harsh economic times, the yield curve inversion is typically followed by a recession.
However, in a period of historically low interest rates, the yield curve may not be as good of an indicator as it once was. “An inverted yield curve has preceded recessions in part because inflation was allowed to get out of control, and the Fed had to tighten, and that put the economy into recession,” said Federal Reserve Chairman Jerome Powell at a news conference. “It’s really not the situation we’re in now.”
What about consumer confidence?
A survey by the University of Michigan shows that U.S. consumer sentiment plummeted to a seven-month low in August on growing concerns about the economy. This represents the biggest drop in confidence since January, which underscores the growing odds of a recession. The consumer confidence will have a significant impact on economic growth, because cautious consumers may reduce their spending in anticipation of a potential recession. Less spending will lead to lower sales, followed by less corporate investment and more layoffs.
How does the trade war with China and the Fed’s monetary policy affect the U.S. economy?
In my opinion, even though most of economic and financial indicators in the U.S. are strong, the risk of recession is highly correlated with two factors: (1) the trade war with China, and (2) the Fed’s monetary and fiscal policy to sustain economic growth. Not only does the U.S. economy suffer adversely from China’s counter-tariffs, the uncertainty about whether the trade war between the two largest economies in the world is going to be escalated in the future imposes a huge dent on investor confidence, which is evidenced by recent enormous volatility in the stock market. The recent interest rate cut by the Fed is also taken negatively by investors who believe that the rate cut is a result of the Fed’s growing concern on lower than expected inflation and potential recession.
Is it a matter of whether or when regarding a recession?
It has been 10 years since the last recession. Considering the fact that any economy follows a boom-recession cycle, the real question is not whether but when the recession is going to hit us.