It’s been a tough couple of years for the American economy, and, while the jobs market has remained surprisingly robust, there are sure signs that a recession may be on the cards.
For instance, consumer spending declined toward the end of 2022, with moderate wage growth causing US households to drastically cut back outlays on services and goods.
Moreover, banks are seeing loan originations shrink in the face of tightening credit standards. This is expected to impact business activity for at least six months, depressing sentiment in both the retail and industrial sectors.
But there’s even more bad news. Three other leading indicators suggest a financial meltdown is imminent – and that’s what we will examine right now.
The Freight Transportation Services Index
The Freight Transportation Services Index (TSI) is an index created by the Bureau of Transportation Statistics to provide information about the current state of the US freight transportation system.
The index measures the monthly changes in the output of services provided by the for-hire transportation industry, including trucking, rail, and water companies. This data is then used to gauge the level of economic activity related to the movement of goods within the space.
As such, the TSI can be used to predict a recession because it reflects the overall need for freight-based services. For example, when they are in high order, this usually indicates the economy is doing well. On the other hand, when the TSI is lower than usual, it signals that it’s slowing and could potentially contract.
Using the most recently updated figures, the index for December 2022 showed a decrease of 2.1% for the fourth quarter compared to the last month of the July to September period. In fact, this was the second-largest quarterly drop since 2013. This decrease indicates that there is a cooling in demand, which could be a sign of an impending recession.
The Treasury Yield Curve
The Treasury yield curve is a graphical representation showing the interest rates on US government bonds of different maturities. It plots bond yields against various time horizons, usually in the form of a line moving upwards. An inverted yield curve comes about when the line moves downwards, meaning that the yields for longer-term bonds are lower than those for shorter-term bonds.
Moreover, the yield curve reflects the difference in the interest rates of short-term and long-term government bonds. Normally, long-term bonds have higher interest rates than short-term ones, as investors desire a higher return for tying up their money for an extended length of time. This results in a positive or upward-sloping curve.
However, when investors become concerned about the economy’s future, they may require higher returns for short-term bonds, anticipating that interest rates will decline. This can result in the yield curve inverting, with short-term bonds yielding higher than their long-term equivalents. That’s why an inverted yield curve has historically been a reliable predictor of recessions, as it indicates that investors are worried about the near-term future and expect lower economic growth and interest rates going forward.
Interestingly, the Federal Reserve Bank of New York uses the spread between the 10-year and three-month Treasury bond yield to indicate the level of activity in the economy. In fact, it pays close attention to the yield curve because it can provide valuable insight into what will happen in the future. For instance, if the yield curve inverts, it suggests that market participants expect the financial system to weaken, which could lead to a slowdown in hiring, consumer spending, and business investment.
Indeed, according to the NY Fed’s own model, there’s a 54% chance of a recession occurring before January 2024, which is the highest it’s been in decades.
The Leading Economic Index
The Conference Board Leading Economic Index (LEI) is a composite index of ten economic indicators designed to provide insight into the direction of the US economy. These include stock prices, new orders for capital goods, and average weekly initial claims for unemployment insurance, among others.
Having first published the LEI in 1959, the Conference Board has been successfully predicting US recessions ever since.
Indeed, one of the critical features of the LEI is its ability to provide an early warning of forthcoming changes in the economy. The Conference Board has identified a six-month decline of 4% or more in the index as a strong signal of an upcoming recession.
For example, the LEI accurately predicted the onset of the 2008 financial crisis when, in early 2007, the index began to decline. This continued over the next several months until it hit the 4% threshold, and a recession officially started in December 2007.
Similarly, the LEI signaled the onset of the 1990-1991 recession. The index began to decline in mid-1989 and hit the 4% threshold in March 1990, just as the recession officially began.
However, the LEI is not a foolproof indicator, and while it has generally been a reliable predictor of economic downturns, there have been seven false positives in the past 60 years.
That said, the Conference Board has the US slated for hard times pretty soon, with negative real GDP per capita growth of 0.1, suggesting a recession is just around the corner.
Final Thoughts: Best Recession Indicators
Although no single indicator can accurately predict a recession, combining certain economic clues can provide you with invaluable insights.
For instance, the Conference Board Leading Economic Index, the Treasury yield curve, and the Freight Transportation Services Index are some of the best markers you can and should keep an eye on.
Other pointers, such as jobless claims, housing starts, and corporate profits, can also provide important information about where the economy is headed. Indeed, by staying vigilant and monitoring these and more, you can protect your portfolio and capitalize on any possible opportunities.
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