U.S. Recession? How Do We Count the Ways?
|Executive Summary
The recent inversion of the yield curve has some observers wondering if a recession in the United States is right around the corner. In our view, talk of an imminent U.S. recession is a bit overdone because the underlying fundamentals of the U.S. economy are generally solid at present. Business sector leverage has risen in recent years, but probably not by enough to lead to recession in the near term, while households have de-levered over the past decade. Growth in many foreign economies has slowed, but it would take a significant downturn in the rest of the world to bring the U.S. economy to its knees. Absent some unforeseen shock, "talking" ourselves into a recession seems to be the most realistic way that the U.S. economy could experience one in the foreseeable future.
How Do Recessions Happen?
The inversion of the U.S. yield curve recently—the yield on the 10-year Treasury security slid below the 3-month T-bill yield on March 22, although the spread has subsequently returned to positive territory—has some observers speculating that a recession is around the corner.1 But economic downturns do not occur in a vacuum. That is, something needs to happen to trigger a recession. In that regard, there are two general catalysts for recession. First, an unforeseen shock (a so-called exogenous shock) can lead to a downturn. For example, the decision by OPEC to embargo oil exports in the wake of the Arab-Israeli War in October 1973 led to a nearly fourfold increase in oil prices. U.S. real GDP subsequently contracted more than 3% between Q4-1973 and Q1-1975.
There have been some disruptions that have hit the economy recently, which we will discuss in more detail subsequently, but none of these shocks rise to the magnitude of the 1973 spike in oil prices. Could another major exogenous shock negatively impact the U.S. economy in the near future? Yes, but exogenous shocks by their very nature are difficult to forecast. Consequently, a forecast of recession that is predicated on some yet-to-occur low-probability exogenous shock is probably not very reliable.
Second, a recession can occur when some sector in the economy becomes unbalanced over time. If the inevitable correction is deep enough and if the sector is large enough, then the entire economy can be dragged down. Examples of these types of recession are the housing boom/bust of the last decade and the "tech wreck" of 2000-2001. So, are there any sectors in the U.S. economy that are out of balance at present? If so, would the inevitable correction in these sectors have the ability to cause a recession in the U.S. economy in the foreseeable future? In the remainder of this report, we analyze different sectors of the economy to determine whether a U.S. recession could emanate therein in the foreseeable future.
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