Last month we had a brief inversion of the yield curve and thus began the ubiquitous debate of the recession countdown clock.
With the curve inverted at the high 2% range, it tells us that the market believes, as do we, that the Fed will be successful at keeping long-term inflation expectations anchored, albeit likely creating a recession to achieve these results.
The rate of change in monetary tightening cannot be overlooked. This combination of late cycle and the Fed moving very aggressively to tighten policy makes us a little more concerned about the outlook for risk assets in this late cycle period.
While the yield curve inversion is widely-regarded as an indicator of an impending recession, there are also other factors that can be used as road signs to a recession.
Output gap
The output gap measures the amount of unused capacity in the economy. Usually, overheating occurs when there is limited capacity left and thus prices become the pressure valve for excess demand.
It is extremely rare for a recession to occur if the output gap is not closed, and has only happened once in history – 1981, although this was only one year removed from the previous recession.
Currently the output gap is closed, however it is worth noting that the participation rate’s influence on unemployment is likely skewing the reading a bit higher than usual.
NIPA profits
National income and product accounts (NIPA) can provide a more interesting detail than just S&P or equity profits. NIPA accounts for the profits of US corporations as a whole, including public, private and S-corps.
This usually peaks a considerable amount of time before the equity market does, as shown in the above chart.
However due to the rate of change of policy tightening, the current number is sufficiently lagged, and therefore may not be as useful as prior cycles.
Currently, NIPA profits are slow. They grew in Q4 last year by a mere 1.1%, although this was in part due to the massive post-pandemic rebound earlier in the year.
Aggregate hours
Because there are high costs associated with labour separation, businesses often try to reduce hours of their workforce before they decide to make redundancies.
The above chart looks at aggregate hours of nonfarm payrolls, private sector seasonally adjusted annual rate, and billable hours.
Currently, these numbers are strong, growing 3.5% in the first quarter of 2022. As an indicator of an impending recession, we would expect billable hours to slow considerably.
Frank Rybinski is head of macro strategy at Aegon Asset Management. The views expressed above should not be taken as investment advice.