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Friday, January 19, 2007

On Turning Bearish

by Calculated Risk on 1/19/2007 02:12:00 PM

I've recently turned bearish on the U.S. economy. This shouldn't be confused with my longer held negative views on housing.

For housing, I'm very confident that 2007 will be worse than 2006 by every material measure: prices, sales, residential construction employment, starts, MEW, percentage of homeowner equity, and the number of foreclosures.

But the impact of the continuing housing bust on the U.S. economy is far less certain. Although I think a recession is better than a "coin flip" in '07, the odds of a soft landing are still good.

Professor Leamer identified two key missing ingredients for a recession: enough job losses, and a credit crunch (see: Is a Recession Ahead? The Models Say Yes, but the Mind Says No). These are the two issues I wrestled with over the holidays, and I couldn't come to a definitive conclusion.

At the core, recessions are about jobs, and it is easy to imagine scenarios with job growth slowing to 100K per month, maybe even 50K per month. But that isn't a recession.

Click on graph for larger image.

This graph shows the average monthly job growth since 1997. In 2001, the economy lost an average of 147K jobs per month - and that was a fairly mild recession.

Over the last three years, the U.S. has added an average of 164K jobs per month. Right now, based on housing starts, it looks like residential construction employment will fall by 400K to 600K jobs by this Summer. Many of these workers will find new jobs, but it is easy to imagine job growth slowing to 100K per month. Adding in other housing related lost jobs, and some ripple effect, maybe growth will slow to 50K per month. Not enough for a recession.

So how can the U.S. economy slide into recession in '07?

Some possible sources: a credit crunch based on bad loans in the RE sector (and possibly in CRE and C&D too), less consumer spending based on falling MEW, and another downturn in the housing market. If all of these can be avoided, a recession is unlikely.

Right now I don't think these problems can be avoided.