These economic indicators are used to help predict an economic recession or downturn in the stock market. They are not perfect and are not a sure thing. They should be used along with other information to help you make your own investment decisions.
The unemployment rate has provided a highly accurate indicator to for the beginning and end of economic recessions. Personnel is often one of the biggest expenses a company will incur. When forecasts predict a decrease in sales, businesses begin to scale back on hiring. If the decrease in sales continues, the next step is to lay off employees. This results is a rise in unemployment. This shows up quickly in Initial Unemployment Claims and shortly thereafter in the monthly Civilian Unemployment Rate, making it an excellent indicator of economic contractions.
Treasury Bond Yield Curve
The yield curve is the difference between the yield on the 10-year Treasury bond and the yield on a shorter-term Treasury bond, for example, the 3 month or the 1 year Treasury bond. The yield curve is inverted if short-term rates are higher that long-term rates, making the spread negative. Inverted yield curves have historically been reliable predictors of impending recessions, which is why people are paying so much attention to the yield curve now. This graph shows that every recession since 1957 was preceded by a yield curve inversion. The lag between the inversion and the following recession has varied with the 10-year and 1-year yields between 8 and 19 months, with an average of about 13 months.
A common interpretation is that the yield curve measures investors’ expectations of economic growth in the current period compared with economic growth in the future. This implies that investors expect current economic growth to exceed future economic growth, indicating a recession is likely. There is some question about the strength of the relationship between U.S. yield curves and recessions. In 1965 the yield curve inverted but a recession did not closely follow. Although yield curve inversions are good predictors of recessions, they are not perfectly correlated and the exact relationship is not completely understood.
In December 2013, the spread between long and short rates was very close to 3 percent. In September 2018, the spread was 0.44 percent for the 10-year and 1-year yields and 0.87 percent for the 10-year and 3-month yields. If the yield curve were to continue its downward trend from its previous high in December 2013, the yield curve would invert in August 2019 (using the 10-year and 1-year yields). Historically, this would predict a recession sometime in 2020.