Is a Recession Looming?

Are we heading for a recession yet again? The yield curve, which compares short-term rates against longer-term rates on a chart, is currently inverted. This means there are some short-term rates that are higher than long-term rates and this suggests less optimism towards the economy, foreshadowing a potential upcoming recession. The normal yield curve is convex or rising with longer- term rates higher than short-term interest. A rising yield curve indicates growth in the economy. So, should we be concern about this trend?

 If you noticed the Q4 GDP numbers that were released last Friday, you might be concerned. GDP in the Q4 advanced at a mere 1.1 percent annual rate–well below the estimated 2.80 percent and down from the 4.1 percent clip reported in the Q3 and the 3.80 percent for the 2004Q4. The 2005Q4 reading was the slowest rate in three years and may support what the yield curve is telling us. But, GDP growth in 2005 was good at 3.50 percent, albeit down from 4.20 percent in 2004.

 You would have to go back to the first quarter of 2002 to see a lower reading than 1.1 percent when it came in at a miniscule 0.2 percent at that time.

 So, what does the Q4 GDP reading tell us? It definitely suggests some weakness in spending by both consumers and companies. Higher oil prices have not helped, not to mention the small market gains in 2005. Durable goods growth of 1.3 percent in December was also well below the 5.4 percent recorded in November and the lowest since a negative 2.1 percent reading in September.

 So, while there are some indications of a pending slowdown, it still may be premature to call one. The Q1 GDP and the next several quarters will help us determine if the Q4 reading was an aberration as some have suggested, or whether it is the beginning of a downward spiral and perhaps another recession.

 In my view, it is too early to expect a slowdown even if the yield curve suggests it.