This Time Is Different (Somewhat) Reliable Recession Indicators

"The macroeconomy is in a relatively healthy state, a benefit for CRE largely, which has also shifted expectations of an optimistic three rate cuts to more likely one or two in 2024. However, signs of a softening economy are showing. The industry is, on the one hand, benefiting from a moderate economy, particularly in multifamily, as employment remains robust. On the other hand, the period of ‘higher for longer’ interest rates are applying significant pressure on the financial market side of the industry. In summary, Q2 data reflects a period of continued stability in most sectors despite ample vulnerability should things sour in the broader economy.”

-Moody's Analytics

Hi Nuvo Community,

Introduction

The yield curve inversion is typically regarded as a signal of impending economic downturns. There’s a joke among economists that the yield curve inversion has predicted 10 of the last 7 recessions. This means that a recession doesn’t always follow a yield curve inversion, but a recession has never occurred without there first being a yield curve inversion. Historically, recessions have occurred approximately 6 months to 2 years after the yield curve inverts. We’re currently at the 2 year mark since the yield curve inverted back in July 2022. Perhaps the more interesting takeaway is that recessions have not occurred until the yield curve normalizes or un-inverts. We’re not there yet. US2YR yields are still higher than 10YR yields.

Full Time Employment Growth

A lesser discussed “predictor” of recessions is looking at Full Time Employment numbers, more specifically, year over year (YoY) changes in those numbers. Since 1980, a recession has followed every time full time employment turned negative. When people start losing full time jobs, it can create a downward spiral where personal spending is cut, service and retail industries struggle, more jobs are cut, more people reduce spending, and so on.

Combining Yield Curve and Employment

Now let’s combine the 2 data series. In the chart below you’ll see Full Time Employment (blue) and US10YR minus US2YR yield (green). Recessionary periods are marked with vertical red bars. Notice that a recession has occurred at or near the point when the yield curve un-inverts (turns positive) and full time employment growth is still negative YoY.

The chart below highlights each occurrence. What the chart shows is a visual depiction of the description above. Currently, full time employment has turned negative YoY, but the yield curve is still inverted. A more concerning occurrence will be if we see full time unemployment continue to fall while the yield curve begins normalizing. Below the chart you’ll see a description of each occurrence.The start of each recession has tended to happen right around a positive 50bps spread US10YR - US2YR.

Analysis of Historical Patterns

Every recession since 1980 has been preceded by a yield curve inversion. Leading up to recessions, our analysis reveals that as the yield curve normalizes, moving back towards a positive spread, there is a notable pattern: full-time employment begins to decline on a YoY basis.

• 1980 Recession: Yield curve normalized approximately 6 months before full-time employment turned negative.

• 1981-1982 Recession: A similar pattern with a lag of around 7 months.

• 1990-1991 Recession: Employment decline followed normalization by roughly 8 months.

• 2001 Recession: The lag was around 9 months.

• 2007-2009 Great Recession: Full-time employment decline followed normalization by nearly a year.

• 2020 Recession (COVID-19): Close to Inversion- The unique nature of the pandemic shortened the lag to approximately 5 months.

July 2024 (Current): Yield Curve has not normalized yet but Full Time Employment has already turned negative. It looks like this is the first time it’s happened in this reverse order.

Conclusion

Clearly, it’s not the charts themselves that predict a recession. We’ve merely created a visual that encapsulates a number of economic conditions that impact employment and interest rates. In future articles we’ll dig into the yield curve a bit more, including a deeper discussion around why the yield curve inverts in the first place. Maybe this time is different?

References

• Federal Reserve Economic Data (FRED), St. Louis Fed

• U.S. Bureau of Labor Statistics (BLS)

All the best,

Yuri - Your Real Estate Investigator

Credit: Brian Underdahl, Chief Executive Officer, Nuvo Capital Partners

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