Recession Signals Are Growing Stronger

Are we heading into a recession?

That seems to be the question on everyone’s mind these days. And while there’s no definitive answer just yet, evidence continues to mount that the nation could be on the verge of experiencing her next economic downturn.

For starters, the basic ingredients are in place. Those would be persistently high inflation and the stringent rate-tightening regime initiated to fight it. According to former Federal Reserve economist Alan Blinder, eight of the previous 11 rate-tightening cycles have ended in recession.[1]

Still, that means three of those rate-hike cycles did not culminate in an economic lull that was large enough to be considered a bona fide recession. So why is there so much speculation that a recession right now is lurking around the corner?

It’s because there’s no shortage of disquieting economic data that seems to be pointing directly at one.

I’ve talked about some of that data recently, such as consumer sentiment. The Michigan consumer sentiment index currently is at its lowest point in history.[2]

That by itself is troubling. Profound lows in the index have almost always occurred just prior to or during recessions.[3] And we are now – as I said – at an all-time low.

But that’s hardly the extent of the unsettling signals. There are quite a few of them, including grim measures recently from two variables that aren’t commonly discussed but which I think can be especially revealing when it comes to evaluating the health of the economy: demand for copper and manufacturing PMI (Purchasing Manager’s Index).

Oh, and there’s this: One of the Federal Reserve’s most prominent economic models effectively says we’re in a recession right now.

I’m going to discuss this information in greater detail shortly. And I want to be clear: none of it is confirmation that we’re in a recession.

But as you will see, neither does any of it come close to reassuring us that we’re not.

Economic Bellwether Copper Has Worst Quarter Since the Financial Crisis

A few moments ago, I alluded to a decline in the demand for copper as one sign that an economic slowdown may be lurking.

Copper is a widely used industrial metal with a tremendous capacity for conducting heat and electricity. It also is very malleable and resistant to corrosion. For these reasons, copper is a favorite of numerous industries, including construction, electronics, home appliances, telecommunications and transportation. As a highly conductive base metal, copper also benefits from being particularly cheap compared to alternatives such as silver.

Because of copper’s enormous popularity throughout industry, demand for the metal is viewed as a bellwether of economic health. And based on that level of demand right now, the global economy doesn’t look particularly healthy.

In fact, copper is continuing to sink this week even as it recently closed out its worst quarterly performance since 2008, dropping nearly 20%. Notably, copper has fallen into a bear market prior to every recession in the last 30 years.[4]

“We interpret this [copper’s recent decline] as a sign that the U.S. economy is losing momentum,” Commerzbank AG analyst Carsten Fritsch said. “Concerns about a global recession continue to predominate on the metals markets.”[5]

Actually, recession concerns seem to “predominate” throughout the economy right now – including in the outlook of those who probably have the best overall view of manufacturing activity.

How do we know that? The S&P 500 Global Manufacturing Purchasing Managers’ Index (PMI) fell to 52.7 in June, the lowest level since July 2020.[6]

PMI is produced from a survey that asks purchasing managers about the status of new orders, factory output, employment, suppliers’ delivery times, stocks of purchases, future output and a host of other variables. It’s a measure that’s highly valued by economists and analysts as an indicator of business conditions from those who truly are on the “front lines.”

Commenting on the sharp drop from May’s 57.0 index measure, Chris Williamson, chief business economist at S&P Global Market Intelligence, said, “The PMI survey has fallen in June to a level indicative of the manufacturing sector acting as a drag on GDP, with that drag set to intensify as we move through the summer [emphasis added].”[7]

In a statement to CNN Business’ Julia Horowitz, Williamson said, “Business confidence is now at a level which would typically herald an economic downturn, adding to the risk of recession.”[8]

That doesn’t sound promising.

But even worse may be this bit of news: the Federal Reserve Bank of Atlanta’s GDPNow measure suggests we could be in a recession right now. 

Atlanta Federal Reserve GDP Tracker Suggests Recession Has Arrived

GDPNow is a model that forecasts GDP growth in what is essentially real time. And according to the model’s latest assessment, the U.S. economy could be mired in recession right now – at least in terms of a longstanding technical definition of recession.

On July 8, GDPNow informed us that output for the recently ended second quarter would contract by 1.2%.[9] By itself, that’s bad news. What makes it worse is that actual GDP for the first quarter declined by 1.6%.[10] So if GDPNow is correct, that means we’ll see two consecutive quarters of negative GDP. And two consecutive quarters of negative output meets the “rule of thumb” recession definition popularly cited for several decades.

Recessions now are declared officially by the National Bureau of Economic Research (NBER). The NBER doesn’t adhere exclusively to the “two consecutive quarters of negative growth” criterion when determining if the economy is in recession. The NBER defines a recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”[11] The NBER evaluates quarterly GDP activity as a principal component of its decision process, but also looks at a variety of monthly measures, including employment, personal income and industrial production.

That said, since World War II, we’ve not had a period of at least two consecutive quarters of negative growth that did not serve as one component of an officially declared recession.[12]

So this GDP outlook isn’t good at all.

Also disturbing is the way that GDPNow measures have been trending recently. Since May 27’s forecast of positive 1.9% through today, the Fed’s model has been projecting a generally steady decline of Q2 GDP.[13]

And as if you needed one more reason to be pessimistic about the nation’s economic outlook, there’s this: GDPNow is rarely wrong in its forecasts.

Nicholas Colas, co-founder of DataTrek Research, notes, “The model’s long-run track record is excellent. Since the Atlanta Fed first started running the model in 2011, its average error has been just -0.3 points. From 2011 to 2019 (excluding the economic volatility around the pandemic), its tracking error averaged zero.”[14]

As I mentioned earlier, there’s some rather compelling data that right now points directly to a recession. But to be fair, it’s worth noting there are highly respected economists – including a Federal Reserve president – who remain unconvinced that America’s economy actually is recession-bound.

For Some, Recession Preparations Could Be In Order

While giving a speech in Zurich, Switzerland recently, Federal Reserve Bank of St. Louis President James Bullard rather significantly downplayed recession prospects.

“I actually think we will be fine,” Bullard told the assembled. “It is a little early to have this debate about recession probabilities in the U.S.”[15]

As for the possibility that rate hikes could send the economy down the recession hole – as they so often have done in the past – Bullard isn’t at all convinced.

“Interest-rate increases will slow down the economy but will probably slow down to more of a trend pace of growth as opposed to going below trend,” he said. “I don’t think this is a huge slowing. I think it is a moderate slowing in the economy.”[16]

Back in April, Ian Shepherdson of global economics research firm Pantheon Macroeconomics was quick to shrug off the news that first-quarter GDP had dropped into negative territory. “This is noise; not signal,” Shepherdson said at the time. “The economy is not falling into recession.”[17]

Shepherdson remains relatively optimistic about the economy’s prospects, buoyed in part by what he says are households that still are sitting on piles of cash accumulated during lockdowns. “Economic growth likely will be modest in the third quarter,” Shepherdson recently told clients, “but our base case remains that a recession is unlikely.”

Far be it from me to disagree with esteemed economists such as Jim Bullard and Ian Shepherdson. But just as I outlined a few minutes ago, there does seem to be a healthy amount of data indicating a pending recession. So if I err, I plan to do it on the side of caution.

For me, that means being proactive in responding to those signs that appear to be recessionary in nature.

Recession preparations will differ from person to person and household to household. When recession fears are growing, financial planners will suggest doing such things as reducing expenses, building up an emergency fund and paying down debt.[18]

Before preparing for a recession, some will want to be absolutely sure that one is coming. However, I would caution against waiting too long before taking meaningful steps that could help minimize the impact of an economic downturn. Previous recessions have proved costly, with one survey revealing that a majority of U.S. workers had not fully recovered from the 2008 recession even a decade afterward.[19]

Just something to keep in mind.

……..
[1] Megan Cassella, Barron’s, “Rate Hikes Raise the Odds of a Downturn. And the Fed’s Record Isn’t All That Great.” (March 31, 2022, accessed 7/6/22).

[2] Ben Casselman, New York Times, “Pessimism about the economy is growing, a U.S. poll shows.” (June 30, 2022, accessed 7/6/22).

[3] Federal Reserve Bank of St. Louis, “University of Michigan: Consumer Sentiment” (accessed 7/6/22).

[4] Phil Rosen, Yahoo Finance, “Copper plunges to its lowest mark in 17-months as the economic bellwether slumps further into a bear market” (July 5, 2022, accessed 7/6/22).

[5] Andrea Bossi and Mark Burton, Bloomberg.com, “Copper Spirals to 19-Month Low as Recession Fears Dominate” (July 5, 2022, accessed 7/6/22).

[6] S&P Global, “PMI falls to near two-year low in June amid contraction in client demand” (July 1, 2022, accessed 7/6/22).

[7] Ibid.

[8] Ramishah Maruf, CNN Business, “All the recession warning signs this week” (June 28, 2022, accessed 7/6/22).

[9] Federal Reserve Bank of Atlanta, “GDPNow” (July 7, 2022, accessed 7/7/22).

[10] Tim Smart, U.S. News & World Report, “1st Quarter GDP Growth Revised Down 1.6%” (June 29, 2022, accessed 7/6/22).

[11] National Bureau of Economic Research, “Business Cycle Dating Procedure: Frequently Asked Questions” (accessed 7/6/22).

[12] Jeff Cox, CNBC.com, “Fed GDP tracker shows the economy could be on the brink of a recession” (June 7, 2022, accessed 7/6/22).

[13] Federal Reserve Bank of Atlanta, “GDPNow.”

[14] Jeff Cox, CNBC.com, “Atlanta Fed GDP tracker shows the U.S. economy is likely in a recession” (July 1, 2022, accessed 7/6/22).

[15] Steve Matthews, Bloomberg.com, “Fed’s Bullard Says US Recession Unlikely and Expansion Is in Early Stage” (June 24, 2022, accessed 7/6/22).

[16] Ibid.

[17] Jeff Cox, CNBC.com, “U.S. GDP fell at a 1.4% pace to start the year as pandemic recovery takes a hit” (April 28, 2022, accessed 7/6/22).

[18] Michelle Fox, CNBC.com, “74% of consumers are concerned about a recession: 5 steps you can take now to prepare” (July 5, 2022, accessed 7/6/22).

[19] Jessica Dickler, CNBC.com, “Nearly 6 in 10 workers are still recovering after the Great Recession” (September 10, 2018, accessed 7/6/22).