The odds of a recession have jumped to 60% over the summer as the economy shows signs of slowing, UBS says

A man looks at signs of a closed store due to COVID-19 in Niles, Ill., on May 21, 2020.

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• The odds of a recession hitting the economy within the next year surged to 60% over the summer, UBS says.
• Odds of a recession previously sat at 40% prior to July macro data and recent interest rate moves.
• "July hard data factor confirms we are in contractionary phase [with] 94% probability," UBS said.

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The economy has a higher likelihood of entering a recession within the next 12 months, UBS said in Tuesday note to clients.

The Swiss investment bank said odds of a US economic recession have surged to 60% when accounting for the most recent economic data. That's a 20 percentage point jump from its June recession odds of just 40%.

UBS tracks an average of three recession indicators to monitor the odds of an imminent economic slowdown. Those three factors include hard macro data, the US Treasury yield curve, and credit data.

"July hard data factor confirms we are in contractionary phase [with] 94% probability," UBS said, adding that it sees the economy in a late cycle phase that is weak, but has not yet collapsed.

"As we have argued before, historically, not all (sharp) slowdowns lead to recession... the US team's model forecast is that the contraction does not morph into a full-blown recession," UBS said.

But the ongoing surge in US Treasury rates, further inverting the yield curve, has signaled a higher chance of an imminent recession.  

"Our recession measure from the rates space depends on the entire slope of the yield curve... much of the curve is now downward sloping, as it usually is prior to recession," UBS said.

But while interest rates and hard macro economic data suggest a recession is imminent, credit data monitored by UBS does not. 

"The recession signal from the credit space—15% in July—is still benign," UBS said. The bank looks at non-performing loans and a survey of senior loan officers, and so far neither are pointing to any signals of distress. 

Resilient corporate earnings can explain why credit data has yet to show worrying signs of an imminent recession, the bank said, highlighting the fact that the economy is throwing off mixed signals that make it harder for both the Federal Reserve and investors to navigate.

For example, while the Fed is chiefly concerned about inflation, there are growing signs that rising prices are "dropping like a rock" leading to outright deflation. That's according to Fundstrat, and if it pans out, it could help reign in interest rates and allow the economy to stick a soft landing, as well as help push the S&P 500 to a new high by the end of the year. 

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