The 2 Most Reliable Recession Indicators

by: Lou Basenese

In yesterday's column, I set out to prove that the U.S. economy is in no jeopardy of entering another recession -- no matter how many times the mainstream financial press tells you otherwise. Admittedly, I used two indicators (Exhibits A and B) that are subject to short-term volatility, which might make you squeamish about putting too much faith in them.

So today, let's focus on two other indicators that not only have a longer-term focus, but also boast solid track records of predicting recessionary periods. Spoiler Alert: Go figure. These indicators also reveal that there's almost zero chance of economic contraction on the horizon.

Take a look:

Exhibit C -- Piger's "Recession Probability Index"

In case you didn't know, University of Oregon economist Jeremy Piger compiles a Recession Probability Index. It tracks the four monthly variables used by the National Bureau of Economic Research (NBER), the official organization tasked with declaring recessions.

For those of you who obsess about the details, the four variables are 1) non-farm payroll employment, 2) the index of industrial production, 3) real personal income excluding transfer payments, and 4) real manufacturing and trade sales. And for those of you who simply prefer the bottom line, here it is, courtesy of Piger:

Historically, three consecutive months of smoothed probabilities above 80% has been a reliable signal of the start of a new recession, while three consecutive months of smoothed probabilities below 20% has been a reliable signal of the start of a new expansion.

Or, more simply, huge run-ups in the probability reading always coincide with the start of recessions. At least, that's been the case for as far back as the data goes (1967). So unless this time is different, which it never is, a recession is nowhere in sight.

The latest probability checks in at a scant 0.16%. Put another way, there's a 1-in-624 chance of recession. For the Nervous Nellies in the bunch who want to keep a constant vigil for a recession, you can track the Probability Index here. It's updated monthly.

Exhibit D -- The 2/10 Spread

For those of you who don’t want to depend on government stats to predict recessions, we can rely on market data, instead. Specifically, the spread (difference) between interest rates on 10-year U.S. Treasuries and two-year U.S. Treasuries.

As Eddy Elfenbein of Crossing Wall Street says, "It has a decent track record of going negative before a recession starts." (Emphasis added.) In other words, it's a leading indicator. And guess what? It's not even close to zero.

The latest reading of the 2/10 spread checks in at 168 basis points. So, again, a recession is nowhere in sight. You can get constant reassurance by monitoring the 2/10 spread here. All you need to do is use the "Create Your Own Data Transformation" option and subtract the two-year data series (DGS2) from the 10-year series (DGS10).

Bottom line: In the words of U.S. President Franklin D. Roosevelt, "The only thing we have to fear is fear itself." Because, based on the data, there's virtually no chance of a recession in 2013.