Normally, the yield curve is a remarkably accurate recession predictor. Don’t believe me? Take a look at this chart:
The yield curve as contracted before each of the last three recession. The experience post-WWII is just as accurate, with the curve contracting before most of the other recessions.
However, there has been some question about the latest contraction with some arguing, “this time is different.” Some of the people making this argument were Fed Presidents, who are very sharp economically. There were few reasons given for their arguments, although I think the best was the term premium is lower. The technicalities of this really aren’t important; only that some very bright people were providing good arguments about why the contraction wasn’t a precursor to the recession.
I was one of those people arguing, “this time is different.” (Notice how I just placed myself in the same company as Fed presidents?) Anyway, I argued that preceding inversions were accompanied by a significant economic event — one that was strong enough to send the economy into a recession.
- The early 90s recession was preceded by the S&L Crisis and the first Gulf War, which caused a spike in oil prices (which itself usually presages a recession).
- The early 2000s recession was preceded by the dot.com bust along with 9/11
- The last recession was preceded by the housing crisis.
This time, there really wasn’t a strong enough event to cause a recession. Yes, the global trade war had hurt manufacturing, but the global service sector was providing enough support to minimize the damage.
Then came the coronavirus. And the news has been uniformly bad. Consider:
- China — one of the largest economies in the world — has had to lock down large swaths of the country in an attempt to control the virus.
- Global supply chains are now in disarray
- Japan’s GDP contracted in the 4Q19.
- Germany is slowing
- South Korea is slowing as well, due to its dependence on China trade
- Italy has closed off towns in an attempt to slow the virus spread.
None of these developments is good for growth.
The virus is still to young an event to make any solid predictions. But at this point, it certainly has the potential to cause a recession due to its ancillary effects that are hitting all over the globe.
