Five factors pointing towards US recession

Money Supply

M1 is falling almost as fast as it during the Great Depression

The Yield Curve

The last time the yield curve (the gap between the 10-year bond yield and the "cash rate"/Fed Funds rate) was this negative was before the deep 1974 recession and the deep and long 1980-1983 recession.

The Fed Funds rate

The Fed Funds rate has risen as much as it did during the '74 and '80-'83 recessions.

Credit tightening

Banks' willingness to lend is collapsing, and banks are tightening credit standards.  This is not yet at levels seen in the GFC, but the data are quarterly, so we don't know what's happened in the most recent three months.

Commodity Prices

I wrote the piece I linked to above a year ago.  

The lag between a sharp rise in commodity prices and the subsequent economic downturn is quite long --- 24 months, though it has been as short as 12 months.  

All 5 Factors

If we combine all these indicators into one index, we get the chart below.  As an "average" of five indicators, it isn't as severe as some of its components.  On the other hand, it has not yet bottomed.

What seems clear enough is that there is likely to be a US recession.  How long and how deep it gets depends on whether there is a banking crisis, whether the Fed raises rates further, and whether the post-Covid rebound in services continues.  I'll keep you posted.

Note that where the 5 factor index appears to coincide with recessions, 
that's because it has been plotted with a 12-month lag.

Yield curves point towards a recession

.... but they have at least stopped falling.

The yield curve as I measure it here is the bond yield less the Central Bank discount rate.  The data for the world is a GDP-weighted average representing countries which make up ±72% of world GDP.  The yield curve leads economic activity by a year or so, but the lag does vary from cycle to cycle.  If we ignore the GFC (which is, however, the closest to the situation we have now)  the lag averages 8 or 9 months, but the median lag is about one year.

The GFC downturn was extended and deepened when the Fed let Lehman's go, causing a banking crisis and a credit crunch, and that would have delayed the lower turning point of the cycle.   Needless to say, there is no guarantee that there will not be another banking crisis, though Central Banks will have learned from past mistakes.  Maybe.  

At any rate, whatever the lag, yield curves are more negative than they have been in 25 years, globally and in the US.  And the rate increase cycle isn't over yet.  The last time (on my data) that the US yield curve was this negative was before the deep 1974 "Great Recession" and double dip 1980 to 1982 recession.  In both those recessions, the downturn was exacerbated by the preceding oil crises.  Of course, we also had an oil crisis in this cycle, with the invasion of Ukraine.  And the effects on inflation of the surge in commodity prices, including oil, are still with us.  

Even though yield curves appear to be troughing, that doesn't mean that the world economy will start recovering immediately.  Don't forget the lags involved.

Yield curve points to deep recession

The yield curve --- here, the gap between the 10-year bond yield and the cash rate/discount rate --- is a reliable lead to economic activity.  The yield curves for both the US and the world are at record (my records, anyway) lows.  The economy lags the yield curve by between 1 and 2 years.  The yield curve may be troughing, but even if it is, the minimum lag before the economy turns is 12 months, which suggests an earliest turning point in mid 2024.

The last time the yield curve was this negative was in the months before the GFC (global financial crisis) in 2007.

Click on chart to see clearer image

Pointing towards recession

In my long experience in economic analysis and forecasting, the yield curve (10 year government stock rate minus the official discount rate) has proved a useful indicator of likely trend in economic activity for the next year or two ahead.  It doesn't always tell you how deep the recession will be, because other factors play a role.  For example the yield curve went more negative in 2001 than it did in 2007/8, but the recession in 2008/9 was deeper than in 2001/2.  That was because there was an additional factor: the housing bubble in the USA, which when it burst, greatly worsened the economic downturn.

There's no US housing bubble now, and though there is a leveraged loan problem, I don't think it's as big as the housing debt implosion was.  However, in China there has been a debt explosion, and a shadow banking explosion, and Trump's trade war is dragging the Chinese economy down.  Because China is so big, a Chinese slowdown affects world economic activity.  China buys lost of stuff from its neighbours, and as the latest PMIs show, they are all struggling.  But slowing Chinese orders and sales have also affected Europe.  And in Europe, political stasis is preventing sensible policies to avert the economic downturn.  So it is very possible that the 2020/21 recession will be worse than the 2001/2 recession.  I don't think it'll be as bad as the GFC, but on the other hand, cash/CB discount rates are so low in developed countries that there's very little firepower left to counter an economic slump.  What will be needed is deficit spending by governments, and here's the problem: the US has already shot its bolt with tax cuts for the rich and companies, and Europe, dominated by Germany, has set its face against fiscal deficits. 

On balance, though, I don't think this recession will be deep, it will prolly be prolonged, and the recovery from it will be much delayed.