Recession Or Not?

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August 5, 2022

Last week we got the Q2 GDP numbers and the Bureau of Economic Analysis (BEA) confirmed that GDP has now declined for two consecutive quarters. What do I make of that? Are we in a recession now? Since several people asked me to comment on this issue, here are my thoughts…

In the United States, we use two different competing definitions of a recession:

  1. We’re in a recession if an independent panel of famous economics professors associated with the National Bureau of Economic Research (NBER) decides so.
  2. We’re in a recession if we experience two consecutive quarters of GDP declines.

Both definitions have their pros and cons. In academic circles, you’ll find more support for the first one. In Wall Street circles, most people follow the second one. And in political circles, people follow the definition that best suits their current needs, i.e., Democrats currently point out that because the NBER hasn’t called a recession, we can’t possibly be in a recession right now (false, because economic turning points are always backdated), while Republicans insist that the second definition is the only one we’ve ever used (also false).

The advantage of the 2-quarter negative growth definition is that you avoid the long delays when confirming the business cycle turning points. The first GDP estimates come out about four weeks after the end of the quarter (though they’d be subject to further revision). The simple two-quarter GDP definition is thus more useful for practitioners, i.e., folks on Wall Street. Academics, on the other hand, can be more “academic”; they can afford to wait a year or two to guarantee certainty about the business cycle turning points. As someone who’s worked in both academic and Wall Street circles, I can tell you that clocks run a bit slower in academia. I once submitted a paper to a journal in 2001 and it was published in 2006. Wall Street wants to move a bit quicker than that!

Waiting for the NBER to make their decision can be frustrating. Take, for example, the 2001 recession. The NBER didn’t announce the March 2001 recession start until November 2001. The timing is ironic because that month turned out to be the end of the recession. That’s like a pregnancy test where the result is available after the baby is born. And the November 2001 end of the recession wasn’t confirmed by the NBER until 2003. So, anyone who argued in the Summer of 2001 that there is no recession because the NBER hadn’t announced one yet, was wrong!

The 2001 recession was special in another way: That recession didn’t even satisfy the second criterion. In 2001, the first and third quarter GDP growth was negative, but the second quarter GDP number was ever so slightly positive. The same pattern, negative-positive-negative growth quarters, also occurred during the 1960-1961 recession. Also notice that the pandemic recession spanned only two months: March and April 2020. Just by dumb luck, the 2020 recession spanned two quarters and indeed produced the “magical” two consecutive quarters. Had the 2020 recession occurred just one month earlier or one month later, then the two recession months would have fallen into the same quarter. And we would have observed only one quarter of negative GDP growth, again falling short of the two consecutive quarters of decline criterion.

So, the two-consecutive quarters of negative GDP growth is certainly not a necessary condition for the NBER to eventually declare a recession. But is the second criterion a sufficient condition for the NBER to declare a recession? At least in recent history, there hasn’t been any 2-quarter contraction outside of an NBER recession.

In the rest of the post, let me try to look for indicators to support the two sides of the “recession or not” argument:

The case against a recession

First, for a recession, the labor market is still too strong. Normally, we see an increase in the unemployment rate and a decline in payroll employment. This morning (August 5, 2022) we just got another Nonfarm Payroll Employment release from the Bureau of Labor Statistics (BLS), and payrolls grew by another strong rate of 528,000 in the month of July. The unemployment rate dropped another notch to 3.5%.

In fact, before the slower-moving monthly numbers display signs of weakness, we normally observe a marked uptick in the weekly unemployment claims, which regular readers of my blog will remember is my preferred labor market business cycle indicator. Sure, there is a bit of an increase, but neither the level nor the slope of the unemployment claims is screaming “recession” right now.

my 2020 post about this topic!

Also, a reliable financial stress indicator is the interest rate spread that corporations must pay over and above safe government bonds. The OAS (option-adjusted spread) of High-Yield bonds spiked a little bit in June this year but has moderated again. What’s more, even that spike was nowhere near what we’ve observed in other recessions (2001, 2008-9, 2020). That little blip on the screen didn’t even come close to some of the other false alarms (1998 LTCM, 2011 downgrade, 2016 Fed scare) that never even came close to a full-blown recession.

10-2 yield curve slope didn’t just dip below zero by a few basis points but by a full 37 basis points (August 3, 2022). The bond market tells us that after the Fed slashes the inflation dragon, it must subsequently lower interest rates again (and aggressively!) to deal with the ensuing recession. The 10-year yield has dropped from 3.49% (June 14) to now well under 3%. That’s not a good sign. I always say that the smartest people on Wall Street are the Fixed Income Folks. They seem to know something that the rest of us didn’t figure out yet!

post a while ago, people at the Fed will probably breathe a sigh of relief if we entered a mild recession that will ease the price pressures sooner rather than later. That’s preferable to the Fed going into Paul-Volcker mode necessitating a positive real(!) Fed Funds rate, which would currently imply a nominal policy rate of, say, 12.1% if targeting a 3% real rate. That would do a trick on the economy!

Another issue that’s not fully appreciated is that the labor market, despite recent gains, is still massively underwater from the pandemic shock. In other words, people pointing to the healthy labor market say that the trajectory is fine. But the level is still severely depressed. More than two years into the economic recovery, nonfarm payrolls just passed their February 2020 peak. If we were to apply a 125,000 monthly trend job growth rate to keep up with population growth, after 2.5 years we’re still 3.75 million jobs underwater, relative to the trend growth path extrapolated forward from the February 2020 peak. So, maybe this could be the first recession where employment doesn’t drop or doesn’t drop much because employment never really recovered from the previous recession.

Markus Spiske from Pixabay

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