One of the best predictors of coming recession is the yield curve. The yield curve represents the difference between short-term interest rates and long-term rates. Normally, we would expect long-term rates to be higher than short-term rates because investors need a higher interest rate to offset the risk of holding a long-term bond. When short-term interest rates go higher than long-term rates, the yield curve becomes inverted.
In the past, this phenomenon occurred prior to a recession. It has accurately predicted recession six out of eight times.
The underlying cause of the inverted yield curve is a tightening of the money supply by the Federal Reserve. Less money, means the price of money (interest rate) goes up. Recently the Feds increased short-term rates to 4.25%. The 10-year bond is currently at 4.4%, so when the FOMC meets again in March, another quarter point increase will shove the short-term rate to 4.5% and unless something drastic happens at the long-term end of the scale, we will have an inverted curve.
Which means that in all likelihood, by the fall of 2006, if not sooner, we will find ourselves in a recession.
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