Feb. 7, 2023

Five key indicators to watch to see if we are heading into a recession

Central banks are battling inflation while trying to prevent the economy dipping into recession
Bear and bull on finance pages of newspaper

As an economist, I closely study that actions of the central banks to see how their actions and policies have a resulting affect on the economy. Although the past can give us data that will help to predict the potential outcomes, each set of socio-political factors surrounding economic situations are unique. At this point in history, we are just emerging from a global pandemic where governments took on a large amount of debt to provide supports to individuals and society. As well, there is an ongoing conflict between Russia and Ukraine that is affecting global supply chains.

The debate among economists and others in the financial sector continues whether we are heading into a recession or not – and what corresponding actions central banks should take. Here are some of the key indicators that we watch, and you can keep aware of as well, to see where the economy may be heading.

1 . Central banks' actions

To start the year, inflation readings in most of the world continued to moderate from the highs of 2022 leading many to believe that the central banks were nearing the end of the current cycle of rate hikes.

The stock markets began betting that the central banks would start lowering interest rates by the middle of 2023. Meanwhile, the central banks are insisting that they would not lower rates this year.

If history is a good indicator, previous episodes of central banks raising rates has resulted in a recession in the near term. If we are heading into a recession what would be the central banks’ policy response? The answer is that it depends on inflation. Absent inflationary pressures, the central banks would reverse the rate hikes, but if inflationary concerns persist, they would keep policy tight. The February 3, 2023 jobs report showed that the labor market in the US remains very strong -- almost too strong -- for the Federal Reserve to pause.  A handful of large technology companies such as Amazon and Google have recently announced large layoffs of employees, but in aggregate the unemployment rate in the US is very low by historical standards.  The tight job market can put upward pressure on wages and cause inflationary pressure. The jobs report moved the markets’ assessed path of rates closer to that projected by the Fed, leading to a new bout of turbulence in stock and bond markets.

What to continue to watch for and why:

The next Canadian jobs report is set to be announced on February 10, 2023. Watch to see if it is strong, this may indicate that the Canadian central bank will hold or further increase rates. The next date for the Bank of Canada to release its policy interest rate decisions is Wednesday, March 8, 2023. If you are making any major interest-rate related decisions, such as mortgages, you may want to keep this date in mind.

2. Stock market activity

With the hope that rate hiking had come to an end, stock markets rallied to start the year. Indeed, most markets climbed about 15 per cent from the lows in the fourth quarter of 2022, but the recent reassessment of the rate path has caused some weakness, particularly for more speculative assets such as growth stocks and cryptocurrencies. Sentiment in the crypto markets continues to be shaken by the collapse of FTX, a crypto exchange.

What to continue to watch for and why:

Many people have investments in the stock markets either investing in individual stocks or as a part of mutual funds. With volatility predicted to continue, those who have immediate needs for their invested assets may need to keep aware. This market may present a good opportunity to buy if you have a longer horizon for your investments.

3. Energy and food prices

Energy and food prices have certainly moderated from their highs in 2022, but these markets remain on edge with the backdrop of the continued Russia-Ukraine conflict. In addition to the loss of supply from these two large exporters, transportation, insurance, and shipping costs for commodities have been far higher than in normal years due to the rerouting of commodities across the globe. For example, Russian oil is still being sold in the United States, but now it is being purchased in India and refined there, before making it to the US. Energy markets also face the risk of undersupply due to the lack of investment in developing new oil fields in the past several years. Food prices are also still relatively high after the shock to global supply chains in the past two years, as well as the increase in fertilizer prices from the energy price shock. Higher food and energy costs continue to cause hardship to lower and middle-income groups, which are a majority of the population.

What to continue to watch for and why:

Everyone in Canada needs to eat and heat their homes so this pressure is hard to escape. With the continued Russia-Ukraine conflict, it is not predicted that these pressures will ease in the near-term. Keep a watch for other factors that may affect supply-chain issues such as major shutdowns or troubles in transportation corridors.

4. The economy of China

The China economy has showed signs from shaking out of the COVID-induced slump in 2022. Indeed, large parts of the economy remained in shut-down mode from the persistence of the pandemic in China until the end of last year. Interest rates in China have been kept low to stimulate growth, and there are signs of an emerging recovery. However, tensions that developed between the US and China on issues such as national security, and production of semi-conductors continue to cause uncertainty about Chinese economic growth.

What to continue to watch for and why:

With indications that China economy may be becoming more active, it may also indicate that some supply chain pressures from this area of the world may ease. Perhaps pricing on technology and some manufactured items may ease.

5. Real estate markets in the US and Canada

Real estate markets in the US and Canada continue to look vulnerable. The rising interest environment has put pressure on many homeowners to sell as they struggle to meet mortgage payments and has discouraged potential new buyers. The strong possibility of a recession and the risk that the jobs market will weaken adds to the stress in these markets. Banks in Canada are hugely exposed to the real estate sector and could face stress with a correction in real estate prices.

What to continue to watch for and why:

Many economists are predicting a drop in housing prices, although this may not be as much in oil-producing provinces. Anyone considering a home purchase must weigh out the possibility of increasing interest rates vs. possible drop in housing costs.

As individuals, we cannot control the socio-economic forces that are impacting what is happening in the Canadian economy. We can gain an awareness of the factors that policy makers look at and use this awareness to influence some of the choices that we are able to make.