Adithya Sanjay: The looming economic downturn might not be so bad

Monday, April 22, 2019 - 4:22pm

It’s no surprise that the economy is booming. For more than 10 years, the market has been on a tear, and after overcoming the threat of recession in 2018, it does seem like we have a couple of years before the market takes its next major downturn. In fact, the Dow Jones Industrial Average has already rallied to recover nearly all of its losses it incurred over last year’s turbulent slump. Accordingly, the March jobs report that recently showed the addition of of 196,000 jobs nationally is not especially shocking. The stats show an unemployment rate of a fiery 3.8 percent, about 1 percent lower than the commonly accepted threshold for full employment (4.1-4.7 percent). But amid all of this positive data, should we still be concerned of the impending crash that everyone seems so anxious about? In short, yes and no. Yes, there will be an economic downturn in the near future, but no, there’s no indicator that it will necessarily be close to a full-on recession.

One potential area for concern in this regard is the aging nature of the tax cuts. The Trump-backed measure that reformed taxes and managed to widely revitalize the market is now about a year and half old and many expect its benefits will continue to fade. Without that driver, the economy will be suddenly exposed to the elements once again, potentially creating a catalyst for a recession in the future. However, this can be combated with good policies from the Federal Reserve, which has recently done a fairly good job in managing inflation. Their decision to stop the planned rate hikes in 2019 was a smart one, having allowed the economy to escape the chokehold the fists of recession almost dragged it into.

Perhaps a more dire forecast, however, is the one offered by the bond yield curve. The March jobs report came on the heels of the first inversion of the bond yield curve since 2007. While such news means next to nothing to the average person, it was enough to send the financial world into panic, with the Dow Jones dropping nearly 500 points in response. The bond yield curve is simply a graph representing the balance in yield between long-term and short-term Treasury bonds. The classic ratios include the 10-year to the three-month and the 10-year to the two-year. While the latter remained in the green — albeit barely — the former dipped under zero, indicating that long-term bonds had less yield than short-term bonds. In short, the market has higher expectations for economic expansion today than it does for the future.

Conditions like this are especially conducive to recession. In fact, all of the past nine recessions since 1955 have been prefaced by a yield curve inversion within two years prior to the recession. And the one time the yield curve inverted without an ensuing recession, the economy hit a downturn nonetheless. While the history may not directly correspond to the situation of the economy today, this precedent is still cause for concern.

But this doesn’t mean you should run to the banks right now and liquidate all your assets. Most don’t expect a coming recession until 2021 — late 2020 at the earliest. Furthermore, the International Monetary Fund “(predicts) a rebound later this year and slightly stronger growth next year for the world economy.” A lot of this can be further delayed given that the U.S.-China trade talks continue to make progress and will come to a final agreement. In fact, according to Scott Minerd, the global chief investment officer of Guggenheim Investments, “The economy could grow more than 2 percent this year. I think that’s going to be the big surprise.”

Another indicator to watch is the unemployment rate. Similar to the yield curve, the unemployment rate is also a potent indicator of recession. Historically, whenever the unemployment rate falls below 4 percent, a recession occurs in the near future. While the converse of the statement is not equivalently true, the recent jobs report did indicate an unemployment rate of 3.8 percent, keeping the labor market below the aforementioned threshold. Could it be that the same thing investors are rejoicing about with the jobs report will end up being the deciding factor in the upcoming economic downturn?

All that said, there is much to be optimistic about the economy at the moment. The recent figures show the effects of over a decade of expansion, and the economy is rejoicing in its success. There’s even the strong possibility that there won’t be a major recession at all at the culmination of this business cycle. The growth can just as well end in a minor downturn before the economy starts back again. But I guess we’ll have to wait until 2021 to actually find out.

Adithya Sanjay can be reached at asanjay@umich.edu.