13 AUGUST 2024

By Raul Elizalde

This article also appeared on forbes.com

Indicators that have been reliable in the past are now signaling that the U.S. economy is on the brink of a recession—or may already be in one. However, much of the data still points to an economy growing at a healthy pace. This apparent contradiction might be explained by the fact that while the overall data, encompassing all sectors of the U.S. economy, does show strong activity, certain areas are thriving while others are contracting. The signs of this uneven performance only become clear when we look beneath the surface of these aggregate numbers.

Recessions, typically defined as two consecutive quarters of negative gross domestic product growth, are notoriously difficult to predict. One of the main challenges is that all economic data is retrospective, reflecting the past, while the future remains uncertain and can change rapidly. Economists have sifted through data looking for clues, but no single, definitive indicator has emerged.

One metric that has shown some predictive success is the U.S. Treasury yield curve. Historically, when the difference between 10-year and 2-year Treasury notes turned negative, a recession often followed within months. This was true for the recessions of 1990, 2001, and 2008, as well as the 2020 recession triggered by the Covid-19 pandemic.

However, despite the yield curve inverting nearly two and a half years ago, the economy has shown few signs of an impending recession. A once-reliable indicator seems to have lost its predictive power.

Another gauge that was once dependable is the rate of unemployment growth, which I discussed in a recent post on Forbes.com. In every recession going back to the early 1960s, the U.S. economy had entered a downturn by the time unemployment rates rose to the levels we see today. Yet, again, no clear signs of a recession have emerged. In fact, the Atlanta Federal Reserve currently projects a 2.9% real GDP growth rate for the third quarter, surpassing the 2.8% growth in the second quarter and the 1.4% growth in the first quarter. This data indicates that the economy is accelerating, not slowing. So, another previously reliable measure seems to have failed.

Before dismissing these indicators entirely, however, it's worth considering whether we may have been interpreting them incorrectly. For example, with the yield curve, perhaps it’s not the moment of inversion between the 10-year and 2-year notes that signals an upcoming recession, but rather when the inversion reaches its peak. If that's the case, the clock may start ticking a year later than initially thought—when the inversion hit its deepest point.

Even so, current data still points to a strong economy, and substantial changes in economic conditions would be needed to suggest a recession is imminent. On the other hand, it’s important to remember that economic data appeared robust before the Covid-19 recession as well. Was the preceding yield curve inversion anticipating that external shock? Most likely not, as many analysts, including myself, were expecting a recession in late 2019 for other reasons. The Covid-19 outbreak overwhelmed those factors, leaving us wondering whether a recession would have materialized without the pandemic.

Another possible explanation is that these indicators remain valid, but our understanding of recessions needs to evolve. Some argue that aggregate GDP numbers no longer capture the full scope of economic activity. In other words, certain sectors of the economy could already be in recession, but overall data may not reflect this.

A recent paper from the San Francisco Fed highlights that different household groups have experienced diverging economic outcomes in recent years. Following the Covid-19 pandemic, all households accumulated significant liquid wealth due to reduced spending opportunities and emergency income programs. However, lower-income households depleted this extra wealth two quarters earlier than higher-income households. Additionally, credit card delinquencies among lower-income groups returned to pre-pandemic levels a year sooner and doubled in size. As a result, both non-essential consumption and savings have sharply declined for these groups.

Given that consumption and savings (which are closely tied to investment) make up the bulk of GDP, the overall positive growth numbers suggest that higher-income groups are driving current economic activity, while lower-income groups may be dragging it down.

There is limited recent data on the distribution of savings and spending by income groups to confirm this assumption. The Bureau of Labor Statistics provides detailed data, but the most recent figures are from 2022. If this assumption holds true, it could mean that a part of the U.S. economy is, in fact, in recession—we just haven’t been looking in the right places. If we separated the higher-income group from the rest, we might see an economy that is thriving alongside another that is in decline.

This hypothesis aligns with recent opinion polls. Research from Affirm, published just weeks ago, indicates that 60% of Americans believe the economy is in recession, despite eight consecutive quarters of positive GDP growth, with another likely on the way.

Some attribute this perception gap to misinformation, but many consumers —particularly those in lower-income groups — report real difficulties making ends meet, which are exacerbated by persistently high prices.

A recent report from the University of Michigan, which produces the Consumer Sentiment Index, echoes the idea that consumers are split. It notes that "higher-income consumers, who are responsible for a substantial majority of aggregate spending, continue to be supported by relatively strong expectations for their incomes and fewer worries about high prices. However, if income growth weakens higher up the income distribution, robust spending is unlikely to continue."

The lesson here might be that traditional indicators—such as the yield curve inversion and rising unemployment—may still be correct. Parts of the economy are contracting, but it’s happening in areas that don’t get enough attention.

Questions? Talk to us.