The Unemployment Rate May Soon Signal A Recession: Update - February 1, 2018

Summary

• For what is considered to be a lagging indicator of the economy, the unemployment rate provides surprisingly good signals for the beginning and end of recessions.
• This model, backtested to 1948, reliably provided recession signals.
• The model, updated with the January 2019 rate of 4.0%, does not signal a recession.
• However, if the unemployment rate should rise to 4.1% in the coming months the model would then signal recession.

A reliable source for recession forecasting is the unemployment rate, which can provide signals for the beginning and end of recessions (Appendix B charts the UER recession indicator for the period 1948 to 2015). The unemployment rate model (article link) updated with the January 2019 rate of 4.0% does not signal a recession.

The model relies on four indicators to signal recessions:

• The short 12-period and a long 60-period exponential moving average ((EMA)) of the unemployment rate (UER).
• The eight-month smoothed annualized growth rate of the UER ((UERg)).
• The 19-week rate of change of the UER.

The criteria for the model to signal the start of recessions are given in the original article and repeated in the Appendix.

Referring to the chart below and looking at the end portion of it, one can see that none of the conditions for the start of a recession are currently present.

• The UER increased to at 4.0% from December’s 3.9%. The short EMA remains below its long EMA, the blue and red graphs, respectively, and the spread narrowed, now at minus 0.04% well below last month’s minus 0.13%.
• UERg had formed a trough in 2015, peaked at minus 4.4% end 2016 and declined to minus 14.1% beginning 2018. Subsequently rising and now at the low level and of minus -5.18%, last month’s minus 10.02% - the green graph.
• Also, the 19-week rate of change of the UER is now at plus 7.1%, last month minus 0.3%, near the critical level of plus 8% - the black graph.

For a recession signal, the short EMA of the UER would have to form a trough and then cross its long EMA to the upside. Alternatively, the UERg graph would have to turn upwards and rise above zero, or the 19-week rate of change of the UER would have to be above 8%.

Currently, the trajectories of the unemployment rate's short and long EMA are both upwards and nearing a cross, UERg is approaching zero, and the 19-week rate of change of the UER is also near the critical level.

Forward simulations of the model shows that if the future unemployment rate remains at 4.0%, or reduces, the model does not signal a recession. However, if the unemployment rate should rise to 4.1% in the coming months then the model would then signal a recession.

Based on the historic patterns of the unemployment rate indicators prior to recessions, one can reasonably conclude that the U.S. economy may soon head into recession.

Appendix A

The model signals the start of a recession when any one of the following three conditions occurs:

1. The short exponential moving average (EMA) of the unemployment rate rises and crosses the long EMA to the upside, and the difference between the two EMAs is at least 0.07.
2. The unemployment growth rate rises above zero while the long EMA of the unemployment rate has a positive slope and the difference between the long EMA at that time and the long EMA 10 weeks before is greater than 0.025.
3. The 19-week rate of change of the UER is greater than 8.0% while simultaneously the long EMA of the UER has a positive slope, and the difference between the long EMA at the time and the long EMA 10 weeks earlier is greater than 0.015.

Appendix B

The UER recession indicator is charted over the period 1948 to 2015 below:

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