A New Recession Call
With President Trump’s new trade agenda and fears about Fed policy inverting the yield curve, the drumbeat of recession calls is picking up.
This week David Rosenberg of Gluskin Sheff & Associates garnered a lot of attention by calling for a recession in 12 months (read more here).
Rosenberg has been unfairly tarred as a perma-bear over the years. He was certainly bearish in the late 90’s and mid-2000s, but he is a flexible analyst who has been bullish the last few years. He resisted calling for a recession in 2011 when many others made the mistake of moving to the dark side.
Rosenberg’s argument is straightforward:
1) Higher inflation in the months to come forces the Fed’s hand.
2) The Fed needs to tighten by at least another 100bps just to get to neutral.
3) Tight monetary policy will invert the yield curve in the second half of 2018, possibly after the September hike.
4) A recession will follow with a lag, say by the middle of next year.
Not So Fast
Tim Duy posted a retort on Friday that is worth a read.
He doesn’t argue against a recession, only that Rosenberg’s timing is off.
“Recessions don’t happen out of thin air. Data starts shifting ahead of a recession. Manufacturing activity sags. Housing starts tumble. Jobless claims start rising. You know the drill, and we aren’t seeing any of it yet.”
Maybe we are biased (OK, we are biased) because we’ve made similar arguments recently (see our yield curve piece here), but for a recession to start in the middle of next year we need to see the data turn down now. However, if anything, the odds favor just the opposite through September at least, especially in the labor markets.
Goldman published a piece this week in a similar vein. Yes, recession risks increase in 2019, but they put the odds at just 18%. Odds go up to 1 in 3 in 2020, as you can see below.
Tim Duy also makes an important point that Fed policy isn’t on autopilot. There is a distinct possibility the Fed takes a pause after the December hike, especially if inflation isn’t bubbling to the surface.
“Also, we really shouldn’t discount the possibility that the Fed pauses even before a yield curve inversion. A market disruption from a trade war or external financial crisis that threatens to spill over into Main Street could put the Fed back on the defensive. So the whole story that the Fed will soon kill this expansion is a bit premature.”
Ironically, any market correction in the second half of 2018 could be the pause that refreshes for stocks at least. If trade jitters, for example, trigger another market correction, it would be a brave soul indeed who would bet the Fed would blindly keep raising interest rates.
Divergent calls like this are what makes markets. We come down on the side of Tim, though. Until we see the hard economic data start to deteriorate we think it is too soon to make the recession call. It will come, but not just yet.
Have a good weekend.
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