Is a Recession on the Horizon? November 27, 2019 In recent weeks, mixed headlines have fueled speculation and concern over a looming recession. Is one inevitable or could small market corrections keep this economic cycle continuing? A recession is what economists describe as a significant decline in general economic activity following two consecutive quarters. The National Bureau of Economic Research (NBER) makes the official call in declaring a recession, which is based on a significant decline in economic activity spread across the economy in such factors as real income, Gross Domestic Product (GDP), industrial production, wholesale-retail sales and employment. At the Mortgage Bankers Association’s annual conference in Austin, MBA Chief Economist and Senior Vice President of research and industry technology Mike Fratantoni forecasted 2020 could possibly see a recession, even as soon as the first half of the year. Prior to past recessions, such as the 2001 dot-com collapse, or the mortgage crisis of 2008, the common denominator was overall tumult that muddied the balance within the economy — accompanied by a triggering catalyst. Today, political instability, a trade war with China, growing national debt, and declining unemployment all seem to be awaiting the next catalyst. The question still remains – why are there so many contradictory opinions regarding the onset of a recession? In short, the devil is in the data — or just as important, in the data one chooses to use. As of late, the marker that’s been getting the most attention is the infamous yield curve, one of the most cited indicators of economic wellbeing. Wall Street keeps close tabs on yield curve inversions, which is the difference between long- and short-term interest rates (10-year and three-month T-bills). Long-term rates are typically higher than short-term rates, but when flipped, a recession is likely. Why? Banks borrow at short-term rates and make loans at longer- term rates. The greater the difference between the two, the more profitable it is for banks to lend money. However, when this gap shrinks, it becomes less enticing to lend. And when it inverts, banks have virtually no desire to lend money, leading to a halt in growth and a recession. Although there is no certainty to when a recession will take place, there are some tell-tale signs to look out for, including: • Inflation Despite numerous factors that contribute to a recession, inflation is one of the major causes. Inflationary conditions are likely to follow as the price of goods and services rise. The higher the rate of inflation, the smaller the percentage of goods and services that can be purchased with the same amount of money as before. In an inflationary environment, people tend to cut out leisure spending, reduce overall spending and begin to spend less and save more. As individuals and businesses curtail expenditures in an effort to trim costs, GDP declines and unemployment rates rise because companies lay off workers to reduce costs. • Too low/high unemployment rate While a low unemployment rate generally signals that the U.S. economy is doing well, a diminished labor pool makes it difficult for firms to find skilled workers. Employers that can’t fill positions become handcuffed in terms of production and growth. In short, businesses cease to expand. Ironically, when businesses stop expanding, they generate less revenue because sales and revenues decrease. When demand is not high enough, businesses start to report losses, then lay off workers to cut costs. Increased unemployment leads to a drop-in consumer spending, slowing growth even further, which forces businesses to lay off more workers. • Slowdown in housing sales and construction A key driver of the U.S. economy is the housing market. So much so, that it adds up to one-sixth of the country’s gross domestic product. So, when new construction and sales both decline sharply, a recession is likely. A decrease in housing demonstrates that builders lack confidence that the economy will perform well over the next six months and that consumers will not have the means to buy or qualify for new homes. On a broader scale, the commercial real estate industry is better prepared for a downturn today than it was in the past. Except for a few markets, there is less new development than past cycles, and owners don’t appear to be overleveraging like they did in the last downturn – owners and lenders appear to be more restrained in this cycle. Interestingly, the CRE market has already weathered a few small slowdowns during the course of this 10- or 11-year post-Great Recession recovery. In 2013, there was a bit of an economic slowdown; and in late 2015/early 2016, the industry saw a more significant slowdown where CRE prices dropped approximately 10% across the board. Some view these slowdowns as market corrections that actually serve to strengthen the industry and prevent a serious recession from occurring, extending the longevity of the overall economic cycle. While it is not possible to truly predict a recession, understanding key indicators can help you make an educated decision on how to manage your assets, investments, and disposable income regardless of mixed news headlines. Stay up to date with the latest KBS news and articles by following us on social media.