Many Americans think they know what a recession looks like. It’s an economic downturn, usually lasting two quarters or more, with output and employment slumping. Companies slash production to limit risk, and the resulting drop in demand puts downward pressure on prices. The unemployment rate rises as staff are laid off, slows spending, and leads to further declines in economic activity. In short, a vicious cycle.
Despite the recent uptick in US jobs, GDP, and stock markets, most economists believe the risk of recession remains relatively high. A new study by FwdBonds estimates a one in three chance of a recession this year and a 50/50 chance of a downturn next year. But the gloomy outlook is not just due to a recent downturn in consumer sentiment or the loss of jobs in the financial sector. It also stems from other factors, including the risk that a Federal Reserve policy to combat rising inflation is overdone.
The informal definition of a recession is two consecutive quarters of declining gross domestic product, or the total value of goods and services produced in the country. But the National Bureau of Economic Research’s Business Cycle Dating Committee — the official recession scorekeepers – gives far more weight to other data points, such as changes in inflation-adjusted income, payroll employment, retail sales, and industrial production. It typically only declares that a downturn is underway months after the fact.
According to the Conference Board, one sign that a downturn is brewing is the number of people who say they are likely to reduce their spending in the coming six months. That’s a worrying trend, mainly since the service sector accounts for most consumer spending. The Conference Board’s Expectations Index fell to its lowest level in over a year, indicating that consumers have begun to worry about the state of the economy and expect to spend less on restaurants, amusement parks, museum visits, hotels, and vacations.
There are other indicators of a downturn: The yield curve, which compares yields on long- and short-term debt securities, is flattening, which is often a warning that the Fed may soon cut interest rates to try to spur growth. And credit-card and auto loan delinquencies are rising, indicating that people are having trouble paying for things.
A last-minute deal to avoid a government shutdown pushed an immediate threat out the door. Still, a significant auto strike, the resumption of student loan repayments, and a potential credit squeeze from higher oil prices all raise the risk that a recession could hit sooner rather than later. Here are six reasons why a downturn remains Bloomberg Economics’ base case.