Are recession leading indicators right?

The  recession warning klaxons are sounding off once again. The Conference Board announced that its Leading Economic Index declined by 0.7% in June 2023 to 106.1 (2016=100), following a decline of 0.6% in May.

The fall was “fueled by gloomier consumer expectations, weaker new orders, an increased number of initial claims for unemployment, and a reduction in housing construction,” according to Justyna Zabinska-La Monica, senior manager, business cycle indicators, at The Conference Board. “The Leading Index has been in decline for fifteen months—the longest streak of consecutive decreases since 2007-08, during the runup to the Great Recession. Taken together, June’s data suggests economic activity will continue to decelerate in the months ahead. We forecast that the US economy is likely to be in recession from Q3 2023 to Q1 2024. Elevated prices, tighter monetary policy, harder-to-get credit, and reduced government spending are poised to dampen economic growth further.”

It’s not the only news suggesting a downturn. There’s the Treasury yield curve inversion, with the 2-year rising above the 10-year starting in early July 2022, more than a year. The 10-year sunk below the 3-month late in October 2022. It’s currently under by nearly 100 basis points.

These are the sorts of signs assumed to predict a recession, based on prior experience. But when/? The usual caveat is that an inversion lasting more than a momentary blip indicates a coming recession a year to 18 months or maybe even two years ahead. So, does that mean tomorrow? Next week? Next quarter?

The problem is that current economic times are odd, with inflation but low unemployment continuing, fueled by an historically highly unusual low number of working people available for the numbers of jobs in the offing.

Jan Hatzius, chief economist at Goldman Sachs Group, wrote in a note last week, “We don’t share the widespread concern about yield curve inversion,” according to Bloomberg. He cut his estimation of a recession likelihood from 25% to 20% after a sharp drop in June’s inflation numbers, which suggest that maybe the Federal Reserve might reduce interest rates without a big economic slump.

“This time around, I am inclined to de-emphasize the yield curve,” said Subadra Rajappa, an interest rate analyst at Société Générale, according to a New York Times report.

Something that is difficult for economists and people in business to let go of is the need for as much certainty as they can get. An example is the Philips Curve, which sees inflation and unemployment in an inverse relationship. Want inflation to go down? Expect unemployment to rise. Except, that’s never been always true since the theory was first suggested.

Related: 4 recession-ready benefits: Tackling employee financial health is a win-win

Perhaps the predictive power of a long-lasting yield curve inversion may turn out to be mostly right, but subject to being wrong. It’s based on the expectations of investors, and who says they’re always right? Any given leading index might be wrong this time around.

Not that it’s smart to ignore warning signs, but remember that they are built on observed correlations, which are far from natural law.