Q4 Economic and Credit Trends: Preparing for a Recession

In November, Equifax and Moody’s joined forces to recap the economic and credit trends of 2018 -- and look ahead to 2019. This is the second of three blog posts where I highlight key takeaways.

Takeaway 2: Preparation is Paramount

One prediction we can make with certainty is that we will have another recession at some point.  The key to forecasting the next recession is not necessarily about when. It's about being prepared for the eventual slowdown in the economy and positioning ourselves for minimal impact.

Recession Risk: Watching the Indicators

In the chart above, you’ll notice that we track a number of key indicators to understand the likelihood of recession. Some of these indicators are leading. Some are lagging. Most are green, meaning the risk of recession within the next 6 to 12 months is low. However, there are three indicators we’re monitoring more closely. One indicator showing high risk is the difference between the current unemployment rate and the unemployment rate consistent with full employment. Typically, if the economy is overheating, you'll see that employment falls below this measure of the “natural” rate of unemployment. By our calculations, the unemployment rate dropped below this equilibrium level last year.

Forecasting the Next Recession

Last summer, the unemployment rate fell to 4.5%. Historically, we've observed that a recession starts about three years after this occurs. Assuming this relationship holds, it suggests that a potential recession could start in the summer of 2020. There are questions about whether this time it’s different. That's because of the unorthodox monetary policy conducted by the Federal Reserve during the Great Recession. However, this is the only indicator that we’re considering a high risk at the moment. While the specific timing is debatable, the next recession will be connected to leverage or over-leverage in some part of the economy. Typically, recessions are caused by some imbalance in the economy where some sector is borrowing too much or borrowing improperly while the economy is growing or overheating. As interest rates rise, some firms with weaker balance sheets are unable to make their debt payments -- ending up in default. This weakness spills over to the broader economy leading to a recession. Companies that keep an eye on these indicators and position themselves to withstand the impacts of a recession before it hits will benefit greatly. Don't miss the first post in our series, Q4 Economic and Credit Trends: Risks to the Economy. In our final post, we'll discuss how the use of economic forecast scenarios are driving lending innovation and how the credit landscape is changing. To learn more, watch one of our U.S. Economic and Credit Trends webinars.