Parsing Recession Risk Is Not Always Straightforward

Trying to handicap economic moves has become a popular, yet whipsawn, source of entertainment, at least among fiscal pundits and the media. But few things are a given and it can be tough to know the ultimate direction when things are moving fast.

And so, there’s particular attention to portents like yield curve inversion or whether there is negative GDP growth for two quarters running. But these are at best rough rules-of-thumb and not definitive. The National Bureau of Economic Research, which is the non-profit that makes the official call on US recessions, explicitly says that there are multiple factors that come into play and no single one is definitive.

Marcus & Millichap address the issue given recent yield curve inversion. Once again, the yield on a shorter-term Treasury note was higher than on a longer-term one (with two-year and ten-year being a common pair for comparison). Is there an association between an inversion and a recession within a couple of years? There certainly seems to be. As the firm notes, “Six of the past seven sustained inversions have preceded a recession by up to 23 months.”

But it’s not a hundred percent and there’s also the question of how long “sustained” means. In the current environment, the firm argues that a number of factors may make the yield curve inversion a false indicator, as sometimes happens:

“Rapid price increases have prompted the Federal Reserve to raise the federal funds rate by 150 basis points so far this year, with the central bank signaling another 75-basis-point hike for later this month. High inflation and the Fed’s response have added upward pressure to treasury rates, particularly for shorter terms. Longer-term rates are not climbing as quickly. The war in Ukraine has motivated more investors from around the globe to seek lower-risk U.S. government debt, such as the 10-year Treasury. This demand is keeping the Treasury note’s yield lower than it otherwise would be. Equity market volatility has also fostered a flight-to-quality toward bonds, which could lead to declining interest rates, at least temporarily.”

There also hasn’t been an inversion between the three-month and ten-year Treasurys, which is considered more accurate. Hiring is still strong, which wouldn’t be in keeping with a typical recession. (Although companies have been creating more jobs than there are people to take them for a few years now, so this may be less dispositive than normal.) Household debt also remains lower than normal, though credit card debt has seen a sharp resurgence.

For CRE, “a vast majority of real estate fundamentals [are] in the green,” with housing needs and consumer spending supporting multifamily, retail, and industrial. Travel is increasing and an aging population means greater need for medical office and senior care. That said, increasing interest rates have turned financing costs into a weight, but still transactions are happening. It’s a time to not let fear drive decisions, but also to pay attention to developing conditions.