Last week, the spread between 10-year and 2-year Treasury bond yields inverted briefly for the first time since June 2007. This spread is an important barometer, as it has historically signaled that a recession could begin in 12 to 18 months. Other yield curves around the world have also inverted, and this development created turmoil midweek in financial markets.
It is important to recognize, however, that the inversion of the yield curve does not necessarily mean that a recession is imminent. The U.S. economy continues to show strength, particularly for consumer spending and in labor markets, and it should grow 2.3 percent in 2019, with 1.8 percent growth forecasted for 2020. Still, the risks of a recession have picked up, rising to around 50 percent over the next 24 months.
There are warning signs out there. For instance, manufacturing productiondeclined 0.4 percent in July, the fifth decrease in output in the sector year to date, and over the past 12 months, manufacturing production has fallen 0.5 percent. In addition, capacity utilization in the sector has dropped from 77.3 percent in December, the best since March 2008, to 75.4 percent in July.
Manufacturing labor productivity fell 1.6 percent at the annual rate in the second quarter, the first decline since the first quarter of 2018. It was pulled lower by reduced output for the second straight quarter, down 2.1 percent in the second quarter. In contrast, nonfarm business labor productivity rose 2.3 percent at the annual rate in the second quarter.
Modest expansions in activity occurred in both the New York and Philadelphia Federal Reserve Bank districts in August, but with hiring growth slowing in both regions. Firms remained upbeat about the next six months, even with input costs expected to rise.
Retail spending continued to strengthen, up 0.7 percent in July and increasing for the fifth straight month. Overall, Americans have accelerated their spending in recent months after being more hesitant earlier in the year, with retail sales up 3.4 percent year-over-year.
Nonetheless, consumer sentiment fell in August to the lowest level since January, with Americans more anxious in light of increased trade policy uncertainty and volatility in financial markets.
Housing starts fell to a five-month low, pulled lower by weakness in the highly volatile multifamily segment. On a more encouraging note, single-family housing starts rose to the best reading since January, and it suggests that reduced mortgage rates, which are the lowest since November 2016, are starting to have an impact.
In addition, housing permits increased strongly, signaling optimism about future activity. Homebuilders are also confident about single-family sales for the next six months, even as they continue to cite challenges with the skills gap and rising costs.