U.S. business cycles tend to start with a robust recovery as the economy emerges from recession. Then after a period of years, an endogenous or exogenous shock pushes the economy into recession.
We now forecast a 55% probability of a recession over the next 12 months.
These shocks range from policy errors to oil market disruptions that first affect the financial sector and then move into the real economy.
After significant disruption to trade policy and financial markets this year, we now forecast a 55% probability of a recession over the next 12 months. The origin of this increase in probability can be traced to the launch of the trade war this year and the shocks that have followed.
To gauge the evolving impact of these events, we introduce our RSM US Recession Monitor. This scorecard intends to provide an accessible set of metrics to monitor the health of the U.S. economy as it absorbs the impact of a sharp increase in prices linked to the trade war.
Read more of RSM’s insights on the economy and the middle market.
Our recession monitor is comprised of 21 variables selected as indicative readings of the business cycle, captured in five different areas of the economy. Each monthly variable is assessed by its direction and by the distance of the current month’s value from its 12-month moving average.
During a recovery, the variables tend to increase faster than their 12-month averages. As the business cycle ends, the variables tend to fall below their 12-month averages, signaling either sluggishness or a sudden drop into recession because of a shock.
The impact of the tariffs was first felt in the financial sector, with the loss of confidence affecting equity markets, bond markets and foreign exchange.
The increased cost of credit will lead to reduced investment that will affect productivity and long-term growth.
The recession monitor shows the current value of each variable, its most recent monthly and yearly changes, and its three-month change on an annualized basis. The last gives an indication of the trend in the variable rather than the noise of a monthly change.
We show the risk of a recession in five areas of the economy—financial, labor, housing, industry and sentiment. In three of these areas—financial, housing and sentiment—the risk of a recession is moderate to high. These are the first areas to feel the effect of a shock like the trade war. But in two areas—labor and industry—the risk is more tempered, a sign of the economy’s residual strength.
Variables that are either quantities or prices are reported in percentages. For variables that are sentiment indicators or ratios, the changes are reported in the unit of the variable.
In the past three recessions, the drop in the financial sector has occurred because of the bursting of the 1995-2000 tech bubble, the housing market bubble that preceded the financial crisis, and the 2018-19 trade war that weakened the economy before the pandemic in 2020.
The deterioration of financial conditions implies negative growth in the coming quarters.
Financial sector
Any shock to the economy will first be felt in the financial sector, and the recent upheaval of trade policies is proving to be no exception. Our measure of financial conditions, which is designed to anticipate the willingness of firms to borrow and lend, is showing perhaps the clearest signal of a coming downturn.
Equity investors have taken notice. The drop in wealth in the S&P 500 index and the increase in volatility have given notice on the direction of the economy…
… at the same time, in the bond market, the flight to cash has pushed 10-year yields higher while the Federal Reserve holds the funds rate at 4.5%, distorting analysis of the front-end of the yield curve. This is true in the 10-year/3-month curve…
… as well as the 10-year/2-year curve. The 2-year yield, though, has most recently declined as investors now expect the Fed to cut rates more aggressively this year.
Amid these changes, lending standards have been tightening since 2023, which will also have consequences for growth.
Housing
Similar high risks of a recession are showing up in the housing market, which is sensitive to interest rates and also to higher input costs in construction on products like lumber, which face higher tariffs under the new trade policy. Consumer confidence also plays a big role in the health of the housing market.
Housing permits peaked in early 2022 and have been moving sideways. A 0.6% decline would signal a recession…
… housing starts have also been in decline since 2022, with erratic ups and downs, most likely because of weather events. An 8.8% decline would signal a recession.
It’s the same story for housing under construction, which peaked in 2023 and has been in steady decline ever since. This decline will have a negative effect on other trades and downstream businesses.
Housing markets cannot be strong unless consumers feel confident to make perhaps the most significant purchase of their lives. Ever since the trade policy spooked financial markets and raised the prospect of surging inflation, consumer confidence as measured by the Conference Board has been in sharp decline, with the March reading already 9.9 points below its 12-month average.
Labor
Not every part of the economy is flashing warning signs of a recession. The labor market, which has been a source of resilience through the recovery from the pandemic, continues to be strong. With an unemployment rate at 4.2%, the economy can be best described as being at full employment, which bolsters household balance sheets and supports consumer spending—70% of the American economy.
Unemployment is creeping higher but remains low. While some of the creep can be attributed to increased labor force participation, the trade shock is yet to be seen in the jobs data. An increase of 0.1 percentage points in the unemployment rate would signal recession. But not yet…
… nor is any risk showing up in first-time claims for unemployment insurance—which are a proxy for layoffs. Jobless claims for unemployment insurance are more likely a coincident or lagging indicator. Even with job cuts in the federal government, a spike in layoffs has yet to take place…
But there are more subtle signs that the labor market is softening. The ratio of people quitting their jobs to the total number of employees peaked in 2022, with the steady decline indicating the growing wariness of employees about the strength of the job market and the direction of the business cycle.
One other, more volatile, measure of the health of the labor market, total change in employment, peaked in 2022, but it is close to its 12-month average. Again, this overall consistency suggests residual strength.
Industry
In perhaps the most paradoxical measure of recession risk, the industrial sector has, like the labor market, shown residual strength. But part of this strength could be attributed to businesses pulling forward orders for capital goods in advance of higher tariffs, which has bolstered business in the short term. The long-term outlook, however, is another question.
Workers have benefited from this pulling forward of purchases. Hours worked, for example, have been increasing over the past five months after trending downward since 2022….
… while industrial production has been increasing this year after being flat since 2022…
… but there is a limit to the benefits of pulling forward orders. The uptrend in non-defense capital goods orders from 2020 to 2023 has flattened, and the risk of purchasing managers front-running the tariffs is worrisome for later in the year.
The dynamic has made for a kind of short-term sugar high in manufacturing. There have been significant increases in wholesale durable goods inventories. But the overall ratio of inventories to sales has been in decline since 2023, which is perhaps indicative of a business cycle coming to an end.
Business sentiment
While the hard data pointing to a recession seems mixed, there is little ambiguity in what we call the soft data, or business and consumer sentiment. In every category, from purchasing managers’ waning outlook, to a pervasive sense of unease over economic policy, to consumer confidence, businesses and consumers have a sense of foreboding about the economy.
Economists have a term for this: the vibecession, where the soft data is flashing contraction even if the hard data has yet to catch up. These soft measures, though, can change fairly quickly as conditions change. Still at least one last piece of hard data—bankruptcies—the risk of a recession is rising.
Sentiment among manufacturers has been underwater from November 2022 until a brief moment in January and February this year…
… even as non-manufacturing sentiment flattened out before increasing at the end of last year, breaking the trend decline since 2022. But sentiment fell below its 12-month average in March…
… one reason for this declining sentiment might be because policy uncertainty is at crisis levels.
In the end, it’s about how viable a business is in this environment. Bankruptcies peaked in June 2023, with the trend decline ending in November. Bankruptcies increased by 4% in March.
The takeaway
The shocks that have followed the upending of longstanding trade policies by the United States have brought on uncertainty and the prospect of higher prices to businesses and consumers. These disruptions have led us to raise our probability of a recession to 55% over the next 12 months.
Our new RSM US Recession Monitor will offer a granular take on the trends taking place across the economy and businesses and consumers try to adapt to a rapidly evolving economic landscape.
