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Recession Remains Unlikely, As Does Recognition Thereof

Despite the somewhat panic-induced stock sell-off this morning (and the much larger sell-off suggested by early morning futures trading, before the Fed announced a triple inter-meeting rate cut), the fundamental metrics of the American economy remain remarkably healthy.

Unemployment is at the notably low level of 5.0%, even after moving up 3/10 of a percentage point last month.  The economy has added jobs for a record-setting 52 consecutive months.  Real GDP growth in the most recent quarter for which we have data (3Q04) was a swift 4.9%.

The related housing and credit crises are proving wider and deeper than hoped, but even this broad-based buffeting has as yet been unable to derail this remarkably resilient economy, whose mettle has already been tested by high energy prices, protracted war, and unprecedented natural disasters.

2008 has certainly been a painful one for anyone net long the stock market, with the S&P 500 down more than 11% year-to-date (including today's sell-off, as of 10:30 am).  And if panic outweighs cool-headed bargain-hunting on Wall Street, stocks could have further to fall before they turn around.  But while the headline-writers will delight grotesquely in the specter of an election year meltdown and attempt to stoke it with bold pronouncements of an economy in shambles, we frankly still don't have much reason to expect a recession in 2008.

A couple weeks ago, I pegged the odds of formal recession in 2008 (two consecutive quarters of negative growth) at 25%, close to the odds of at least one unexpected exogenous shock (a serious oil spike, a terrorist attack, the wrong electoral outcome, etc.).  Now, we can probably add "self-inflicted recession" to the mix.  If campaign gasbaggery, spastic Congressional response, media castigation, and suffusion of investor panic conspire to convince everyone that the world is indeed ending, that prophecy might just self-fulfill (in the form of a mild recession, anyway), as investors recede and legislators overreach, drying up capital markets and hobbling what's left with the indelicate hand of government intervention.  Incorporating this possibility of self-inflicted wounds, let's boost the odds to 1/3.

Lest you think me a blind cheerleader, consider the Fed's own economic model, which (according to some folks who've attempted to recreate it) might indicate a likelihood of recession as low as 10%.

The Federal Reserve doesn’t expect the U.S. to enter recession, Chairman Ben Bernanke has said, and a model developed by his staff appears to back him up.
...
The Fed economists did not update the model to the present, to tell us what it now says the probabilities are, so The Wall Street Journal asked [Brian Sack, economist at Macroeconomic Advisers] to do it. Mr. Sack said he did not exactly reproduce the Fed model – for example, they used a different credit spread, quarterly instead of monthly data, and they go back further in time. Recently, credit spreads have widened sharply, but the yield curve has steepened. “The offsetting effects capture a lot of what is happening in the outlook. The economy is worse off, as reflected in wider spreads, but the Fed is riding to the rescue, as reflected in the steeper curve.” Based on recent quotes, “the odds of a recession [in the next 12 months] are less than 10% (see chart below), down from over 40% in early 2007,” Mr. Sack says.

He adds: “We run bunch of these types of models, and they all give different results, so I’m not sure any single model should be taken too seriously. I think we would subjectively put the probability of recession above the 10% from this model, but below the 30% to 50% figures that are commonly cited.”

Don't expect such heresy to be repeated much outside the pages of The Wall Street Journal (or at least its economics blog, quoted above).  The non-negotiable message right now is "World markets tank on growing recession fears" and the only interpretation of this morning's Fed action is that Bernanke is trying valiantly (albeit in vain) to prevent that recession from dwarfing the Great Depression.

If you wonder whether I overestimate the media's perverse fixation with being pitched into recession, think back to last February.  Former Fed chairman Alan Greenspan told a group of businessmen in Hong Kong that a U.S. recession was unlikely.  The AP immediately printed the headline "Greenspan Warns of Likely U.S. Recession."  A couple months later, Greenspan specified that he saw a 1/3 chance of a recession.  Again, the AP moaned of our economic plight, clumsily wielding Greenspan's prediction (which, of course, predicted 2:1 odds against recession) to counter optimistic forecasts from the Bernanke Fed and the Bush administration, both of which had (like Greenspan) said they believed a recession was unlikely.

The quarter immediately following those remarks (our most recent quarterly data) saw the swiftest economic growth in four years.  The fourth quarter of 2007 (data for which will be released next Wednesday) will certainly show deceleration.  The market expects a print of 1.2% real GDP growth - clearly below trend, but equally clearly above 0.0%.

We're by no means immune from recession in 2008, but notwithstanding the genuine and complex economic mess of the housing/credit turmoil, there's little evidence that we're careening inexorably toward one.  Truly exogenous shocks aside, most of the determinants are still under our collective control.  If investors are inspired to panic, if legislators with economic purview (some of whom can't tell a Treasury Secretary from a Fed chairman) succumb to grand mal intervention, and/or if voters are indiligent in their selection in November, this business cycle might yet find its way into recession, but it will likely be of our own design.

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Recession Remains Unlikely, As Does Recognition Thereof

Despite the somewhat panic-induced stock sell-off this morning (and the much larger sell-off suggested by early morning futures trading, before the Fed announced a triple inter-meeting rate cut), the fundamental metrics of the American economy remain remarkably healthy.

Unemployment is at the notably low level of 5.0%, even after moving up 3/10 of a percentage point last month.  The economy has added jobs for a record-setting 52 consecutive months.  Real GDP growth in the most recent quarter for which we have data (3Q04) was a swift 4.9%.

The related housing and credit crises are proving wider and deeper than hoped, but even this broad-based buffeting has as yet been unable to derail this remarkably resilient economy, whose mettle has already been tested by high energy prices, protracted war, and unprecedented natural disasters.

2008 has certainly been a painful one for anyone net long the stock market, with the S&P 500 down more than 11% year-to-date (including today's sell-off, as of 10:30 am).  And if panic outweighs cool-headed bargain-hunting on Wall Street, stocks could have further to fall before they turn around.  But while the headline-writers will delight grotesquely in the specter of an election year meltdown and attempt to stoke it with bold pronouncements of an economy in shambles, we frankly still don't have much reason to expect a recession in 2008.

A couple weeks ago, I pegged the odds of formal recession in 2008 (two consecutive quarters of negative growth) at 25%, close to the odds of at least one unexpected exogenous shock (a serious oil spike, a terrorist attack, the wrong electoral outcome, etc.).  Now, we can probably add "self-inflicted recession" to the mix.  If campaign gasbaggery, spastic Congressional response, media castigation, and suffusion of investor panic conspire to convince everyone that the world is indeed ending, that prophecy might just self-fulfill (in the form of a mild recession, anyway), as investors recede and legislators overreach, drying up capital markets and hobbling what's left with the indelicate hand of government intervention.  Incorporating this possibility of self-inflicted wounds, let's boost the odds to 1/3.

Lest you think me a blind cheerleader, consider the Fed's own economic model, which (according to some folks who've attempted to recreate it) might indicate a likelihood of recession as low as 10%.

The Federal Reserve doesn’t expect the U.S. to enter recession, Chairman Ben Bernanke has said, and a model developed by his staff appears to back him up.
...
The Fed economists did not update the model to the present, to tell us what it now says the probabilities are, so The Wall Street Journal asked [Brian Sack, economist at Macroeconomic Advisers] to do it. Mr. Sack said he did not exactly reproduce the Fed model – for example, they used a different credit spread, quarterly instead of monthly data, and they go back further in time. Recently, credit spreads have widened sharply, but the yield curve has steepened. “The offsetting effects capture a lot of what is happening in the outlook. The economy is worse off, as reflected in wider spreads, but the Fed is riding to the rescue, as reflected in the steeper curve.” Based on recent quotes, “the odds of a recession [in the next 12 months] are less than 10% (see chart below), down from over 40% in early 2007,” Mr. Sack says.

He adds: “We run bunch of these types of models, and they all give different results, so I’m not sure any single model should be taken too seriously. I think we would subjectively put the probability of recession above the 10% from this model, but below the 30% to 50% figures that are commonly cited.”

Don't expect such heresy to be repeated much outside the pages of The Wall Street Journal (or at least its economics blog, quoted above).  The non-negotiable message right now is "World markets tank on growing recession fears" and the only interpretation of this morning's Fed action is that Bernanke is trying valiantly (albeit in vain) to prevent that recession from dwarfing the Great Depression.

If you wonder whether I overestimate the media's perverse fixation with being pitched into recession, think back to last February.  Former Fed chairman Alan Greenspan told a group of businessmen in Hong Kong that a U.S. recession was unlikely.  The AP immediately printed the headline "Greenspan Warns of Likely U.S. Recession."  A couple months later, Greenspan specified that he saw a 1/3 chance of a recession.  Again, the AP moaned of our economic plight, clumsily wielding Greenspan's prediction (which, of course, predicted 2:1 odds against recession) to counter optimistic forecasts from the Bernanke Fed and the Bush administration, both of which had (like Greenspan) said they believed a recession was unlikely.

The quarter immediately following those remarks (our most recent quarterly data) saw the swiftest economic growth in four years.  The fourth quarter of 2007 (data for which will be released next Wednesday) will certainly show deceleration.  The market expects a print of 1.2% real GDP growth - clearly below trend, but equally clearly above 0.0%.

We're by no means immune from recession in 2008, but notwithstanding the genuine and complex economic mess of the housing/credit turmoil, there's little evidence that we're careening inexorably toward one.  Truly exogenous shocks aside, most of the determinants are still under our collective control.  If investors are inspired to panic, if legislators with economic purview (some of whom can't tell a Treasury Secretary from a Fed chairman) succumb to grand mal intervention, and/or if voters are indiligent in their selection in November, this business cycle might yet find its way into recession, but it will likely be of our own design.