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Is Another Recession Coming?

Updated: Apr 6, 2019


With Germany’s ten-year bond yield curve falling below 0% for the first time in over two years, the global economy seems to be in an increasingly precarious spot. When taking into account the fact that the German ten-year bond is one of the most stable assets in the world, many people are wondering: Will thee be another recession?

A recession is defined as a prolonged period of significantly diminished economic activity. While this may seem relatively inconsequential, as economic activity generally fluctuates a bit, the recession is a positive feedback loop; as more people are unemployed, they spend less, which causes companies to fire more people (or liquidate altogether), which causes more unemployment. Eventually, it can spiral into a global depression that has extensive effects, such as a slowdown in R&D or increased political instability in fragile countries.

Recessions are a regular part of the business cycle, happening on a regular basis; however, sufficiently large events can trigger recessions, like OPEC’s quadrupling of oil prices that led to the 1973 recession.

Predictors


Contrary to popular belief, the unemployment rate is not a good predictor of a recession, as it is a lagging economic indicator. When the Great Recession began in December 2007, employment was under or close to full employment levels until May 2008. This, however, does not mean that lagging economic indicators are completely useless; they can serve to confirm if an event happened.


If the yield curve of bonds inverts, then there may be a recession. This happens when long-term bond yields fall below short-term yields; this recently happened in Germany, which is why many people are worried. Every recession since 1970 has happened shortly after an inverted yield curve, which makes it a good leading indicator.


If a broad stock index, like the S&P 500 or DJIA, declines, then there may be a recession. These are leading indicators, too, since they usually precede a recession by several months.

The business cycle has four phases; expansion, or economic growth; peak, or the highest GDP attained during the cycle; contraction, or a recession; and trough, or the lowest GDP attained during the cycle. Many people believe that the world is currently at the peak, meaning that a recession may be imminent.


Outlook


Personally, I would argue that we will have a recession in the next five years. The inversion of Germany’s yield curve is already a bad sign; in addition, world GDP growth has slowed down significantly. The US added 20,000 jobs in February 2019, far short of the 150,000 needed to keep expanding. Finally, the Federal Reserve’s monetary policy has been more defensive, with it projected to not raise rates at all in 2019. While the US unemployment rate is still below 5%, it is a lagging indicator, so it will not be useful in predicting a recession. Taking into consideration the evidence, along with our position in the business cycle, it is reasonable to claim that a recession may be coming.

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