Recession on the Horizon?
While North Korean nuclear tests and congressional page e-mails are capturing the national headlines, there’s another insidious threat lurking below the geopolitical surface—the possibility of a domestic recession. At this point, we’re not hearing the “R” word in polite cocktail conversations, but it is surfacing in discussions with bankers and others closely linked to the comings and goings of our overall economy.
Consider how economists at top Wall Street firms including Goldman Sachs Group have cut growth forecasts for the year to around 2 percent. And former Fed figureheads aren’t optimistic. According to former Federal Reserve official Peter Hooper, “We’re decelerating fairly significantly.” Hooper, who is now chief economist at Deutsche Bank Securities in New York, was quoted with this pessimistic perspective in Australia’s paper, The Age.
But perhaps most scary are classic early warning signs that point to a halt in economic growth. In early October, The Dallas Morning news ran an article that discussed the tell-tale signals of a possible recession, noting that “new-car sales are down about 5 percent from a year ago.” According to the paper, “This has happened six times over the past 40 years, and in every instance the economy was either lapsing into recession or already in recession.”
Another more controversial recessionary predictor is what’s termed in economic circles as the inverted yield curve. An inverted yield curve occurs when long term interest rates are lower than short-term ones. This is a situation which we’re in right now. According to The Dallas Morning news, “The 10-year Treasury note ended the quarter with a yield of 4.63 percent, with the 2-year note slightly higher with a yield of 4.68 percent.”
The challenge of inverted yield curves makes access to capital challenging, cutting off fuel to stoke the private sectors’ growth fire. According to Nathan Powell, an Economist at the FDIC, “An inverted yield curve takes away the incentive for. banks to make loans. For example, if a bank is paying 5 percent on a one-year certificate of deposit, it won’t have much incentive to lend money long term at 5 percent or less. In other words, because the profit margin is too small for the risks involved, banks reduce lending, and that slows the economy.” Powell also argues that an inverted yield curve is by no means a guarantee of a recession. “History suggests that the odds of recession increase when the yield curve spread flattens or becomes inverted. But past recessions only occurred with a high frequency after the curve inverted by a significant amount for a sustained period of time.”
Still, the combination of a stalled and slumping housing market, declining auto sales, and suggestive debt yield curves do not combine to paint a rosy picture for the economy in the coming 12 months. While many economic forecasters are suggesting a better picture than the one framed in this column, it is important to note that according to market historian James Stark, “Not one recession in the past 50 years was forecast in advance by a major poll of economic forecasters.” Clearly, spotting recessions is not a skill economists like to claim as their own. But perhaps given the direction it appears we might be headed in, it might be a handy skill to bring to bear.
Even if a recession does not occur, manufacturers can plan for the worst by bringing down the costs of their operating structure. In a capital constrained environment, reducing the costs of goods sold through better direct materials sourcing and trimming unnecessary indirect expenditures is perhaps the easiest lever many companies will have to pull. But they should not slop there. From examining manufacturing processes for unnecessary waste to reducing physical inventories, there are many additional strategies even small manufacturers can take to prepare for volatile times ahead.