Thursday, November 02, 2017

Is a Recession Imminent?

by Bill McBride on 11/02/2017 02:43:00 PM

Last Friday I posted five economic questions I'm frequently asked.  Earlier this week I discussed: Are house prices in a new bubble?

Another common question is: Is a recession imminent (within the next 12 months)? Once again my short answer was: No.

First, I use NBER to date recessions and expansions. The trough of the recent recession was in June 2009, and the current expansion has lasted for 101 months. This is already the 3rd longest expansion in NBER history (since mid-1800s), trailing only the '90s expansion (from March '91 to Mar '01), and the '60s (from Feb '61 to Dec '69).

However, just because this is a long expansion, doesn't mean the expansion will end soon. Expansions don't die of old age!  There is a very good chance this will become the longest expansion in history.

There are several reasons this has been a long expansion.  Recoveries from a financial crisis tend to be slow since it takes years to resolve all the excesses.  Also, there was an early pivot during the recovery to fiscal austerity that slowed the pace of recovery.   Importantly, the Federal Reserve didn't overtighten like in the '30s (a lesson learned).  And housing, always a key cyclical sector, didn't participate early in the recovery since there were so many foreclosures.  This delayed the usual boost from housing, but housing now a key driver of the expansion.

Usually there is a clear reason for a recession.  When I started this blog in January 2005, I was writing about the "housing bubble", and expressing concern that the then coming housing bust would lead the economy into a recession (and possibly a financial crisis).    But I wasn't forecasting an immediate recession, and at the beginning of 2006, I thought it was too early to call for a recession.  It wasn't until 2007 that I started forecasting a recession (just made it with the recession starting in December 2007).

This isn't to be self-congratulatory on my forecasting, but rather to point out there was a clear reason (housing bust), and that it took time for the housing bubble to burst, and more time for the bust to drag the economy into recession.

So what would be the reason now? Most of the post-WWII recessions were caused by the Fed tightening monetary policy to slow inflation. I think this is the most likely cause of the next recession. Usually, when inflation starts to become a concern, the Fed tries to engineer a "soft landing", and frequently the result is a recession. Since inflation is not an immediate concern, the Fed will probably raise rates slowly.

I see analysts express concern about the yield curve, the debt, war with North Korea, hyperinflation and more.   I don't think these are a concern.

Note: Incentives motivate Wall Street economic forecasters to always be optimistic about the future (just like stock analysts). Of course, for the media and bloggers, there is an incentive to always be bearish, because bad news drives traffic (hence the prevalence of yellow journalism).

If a recession happens quickly, it will probably be the result of an exogenous event, such as a pandemic, significant military conflict, disruption of energy supplies for any reason, a major natural disaster (meteor strike, super volcano, etc), and a number of other low probability reasons. All of these events are possible, but they are unpredictable, and the probabilities are extremely low that they will happen in the next few years or even decades - so I just ignore these possibilities.

So what am I watching? Housing. (Housing starts, New home sales, Residential Investment). I've written extensively about how housing is usually the best leading indicator for the economy.

The following graph shows Single family housing starts, New Home Sales, and Residential Investment (RI) as a percent of GDP.

Starts, new home sales, residential Investment Click on graph for larger image.

The arrows point to the peaks and troughs for these three measures.

The purpose of this graph is to show that these three indicators generally reach peaks and troughs together.  And to show that housing usually turns down prior to a recession.

Note that Residential Investment is quarterly and single-family starts and new home sales are monthly.

A key exception was the 2001 recession that was due to the bursting of the stock bubble and less business investment.   But that was easy to understand and forecast. 

Right now I don't see any reason for a recession in the near term (through at least 2018).