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What are the warning signs of a recession? Experts say inflation, political turmoil, fear

WATCH: The “r” word is being thrown around once again in the U.S. as markets reacted to President Donald Trump’s trade war with China. So what are the warning signs of a recession?

Recession paranoia has intensified over the past few weeks as a number of market indicators are sounding alarm bells for economists.

While U.S. federal officials have attempted to quell these fears by assuring the public that the market is strong, the National Association for Business Economics warned earlier this week that the inversion of the yield curve coupled with U.S. President Donald Trump’s trade policies have three-quarters of its economists predicting a recession.

WATCH: White House officials pushed back against concerns that economic growth may be faltering.

White House says ‘no recession’ despite market turmoil
White House says ‘no recession’ despite market turmoil

Because of the strong trading relationship between Canada and the United States, many Canadian economists are concerned that political turmoil in the United States could negatively impact the Canadian economy as well. Global News previously reported that over two-thirds of Canada’s exported goods were sold to the U.S. in 2017, according to data obtained from the UN Comtrade Database.

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In addition, Canada sold more than five times as much merchandise to the U.S. in 2018 than it sold to its other top nine trading partners combined.

In addition to the yield curve inversion and political upheaval, experts told Global News that other warning signs include rising inflation, falling employment rates, falling GDP and a general lack of confidence in the market.

We asked experts to list the key indicators that a recession is on the way, and whether or not those indicators are present in the market today. Here’s what they said:

Interest rates

Over the past few weeks, close attention has been paid to the inversion of the U.S. yield curve, and by extension, the Canadian yield curve as well. This market signal is actually predictive of future higher interest rates as it means that short-term bonds are yielding higher returns than long-term bonds.

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“The yield curve inversion is more about speculation on long- and short-term interest rates,” explained Colin Cieszynski, a chief market strategist with SIA Wealth Management.

According to Cieszynski, the global economy has recently recovered from the 2008 recession. Following a period of recovery, consumer demand increases significantly and puts upward pressure on inflation, which forces the banks to slow the market down by raising interest rates.

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“Often, in the past, they would go too far, and then that would tip the economy into a recession,” he explained.

Eric Kam, an associate professor of economics with Ryerson University, notes that while Bank of Canada interest rates holding steady at 1.75 per cent, it’s too soon to worry about this indicator.

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“The interest rate is still low, the cost of borrowing money is still low. So, there’s nothing tangible that I think you can put your hands on that says we’re in for trouble,” he explained.

However, he notes that if Canada’s central banks were to raise interest rates, he’d be more concerned about the economy tipping towards a recession.

Risk level: Low to medium

The labour market

Kam explained that as part of taking a macroeconomic view of the economy, it’s important to look at the labour market as an indicator of overall market health. In Canada, he notes, job growth remains strong.

The Canadian unemployment rate currently sits at a low 5.7 per cent, which is still higher than the record-low U.S. unemployment rate of 3.7 per cent. Based on these numbers, Kam notes that employment levels are not currently pointing towards a recession.

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Patrick Jankowski, an economist and senior vice president with the Greater Houston Partnership, says one of the greatest indicators of a recession is monthly job growth. At the moment, he said in a statement, the U.S. has been adding jobs at a rate of 200,000 per month, indicating a significant amount of purchasing power in the economy.

“It also indicates that businesses expect sales and production to keep on growing, otherwise they wouldn’t be expanding their workforce. If we start to see a significant slow down in hiring, the public should be concerned,” he added.

Risk level: Low

Inflation

Cieszynski notes that, while Canadian unemployment levels are currently at all-time lows, wage inflation rates are high. Wage inflation refers to the year-over-year rate of wage increases in a country.

Last month, while the Canadian economy lost over 24,000 jobs, wage growth hit its highest level in almost a decade., while last year, the U.S. workers saw the fastest wage growth in a decade — an increase of 3.1 per cent.

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Inflation and unemployment rates have often had an inverse relationship because a lack of job-seeking talent means that employers will need to bid for workers. This often leads to an increase in overall market wages, which tends to coincide with an increase in overall market inflation — another recession indicator.

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Because wage inflation often puts greater financial stress on corporations, it often coincides with an increase in the prices of consumer goods.

“When you look at things like the inflation rate, what you’re trying to find there, of course, is purchasing power,” Kam explained.

In Canada, the consumer price index, which is indicative of inflation, was up two per cent in July, versus the 1.7 per cent predicted by economists.

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“Wage inflation has been creeping up, particularly in the U.S. That’s the one area that you have to watch because when wages go up, they don’t go back down so easily,” Cieszynski said.

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Wage inflation can lead to a number of things, including prompting the central banks to raise interest rates and pushing up commodity prices (a.k.a., lowering purchasing power).

Inflation refers to a general decrease in purchasing power, which if elongated could lead to a retraction in the market.

Risk level: Medium

GDP

According to Kam, the most effective way to gauge whether the economy is expanding or contracting is to evaluate a country’s gross domestic product (GDP). The financial website Investopedia defines a recession as two consecutive quarters where the GDP contracts rather than expands, which causes businesses to slow expansion.

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GDP represents the market value of the goods and services produced within a country during a given period.

READ MORE: Dow Jones sinks 800 points amid fears of recession

“I probably put GDP first, because GDP is like a scoreboard. When you look at GDP, you see how the economy scored,” Kam explained.

In Canada, second-quarter GDP growth hit 1.3 per cent annually, following a 1.6 per cent annual growth rate in the first quarter. According to the Bureau of Economic Analysis, the U.S. GDP increased at an annual rate of 2.1 per cent in the second quarter of 2019, and growth is predicted to be below two per cent in the third quarter.

Risk Level: Low

Political turmoil

The possibility of a trade war between the U.S. and China, as well as general political unrest in Europe, is perhaps one of the most significant recession indicators present in the market today.

“The North American economy by itself is doing fairly well,” Cieszynski said. “The worry is more that an external shock could tip the world into a recession. There are ramifications of a trade war.”

Between the United States broadening its threat of placing tariffs on China, Brexit, the spiralling German stock market and the recent resignation of the Italian prime minister, Cieszynski says there’s plenty of fuel for the fire.

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While the political landscape is currently “flashing yellow,” he notes that there are ways to reverse this trend.

“It’s important that politicians have the will to manage it. I think the issue for the last decade is that politicians have left it to central bankers to manage the economy. But the bigger issue is that right now, the market doesn’t have any faith in the politicians.”

In addition, Kam warns that an increase in the trade deficit between the United States and Canada– or even the perception that the trade imbalance between the U.S. and its major trading partners has increased — could be the kick-starter for a dip in the market.

READ MORE: Germany, the U.K. and others are flirting with recession. Can Canada dodge the economic bullet?

“I think our balance of payments is at risk if the United States gets more protectionist with its policies,” Kam said. “If you’re asking me what I think could kick start a recession, I think it would be the perception that our trade imbalance is past the point of no return.”

Cieszynski agrees, saying that “imbalances have been created that if left unchecked could eventually lead to some sort of negative reaction.

He adds that because these challenges are political rather than purely financial — as was the case in 2008 — it may be more challenging for Canada to rely on its tightly regulated banking sector to avoid the worst of a U.S. crash.

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Risk level: High

Fear

Many economists believe in what Kam describes as “the economics of self-fulfilling prophecy,” which indicates that recession paranoia could bring on a recession in reality.

“What you’re seeing right now is this contagion effect,” Kam explained. “Is it because of employment statistics? No. Interest rates? No. Inflation statistics? No. Manufacturing? No. It’s all because of the supposed war between Donald Trump and the rest of the world.”

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He said that as people become more concerned about a retracting economy, they cut their spending, which on a large scale can lead to an actual retraction in the market.

“Here, the biggest fear is fear itself. When you look at the underlying skeleton of the economy, it’s doing quite well.”

Risk level: High