Code Yellow, Too Early to Call a Recession

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Special Guest Blogger: Tim Kearney

As noted recently, there has been a run of disappointing manufacturing data thus far in 1Q19. This includes two consecutive monthly drops in manufacturing production, softer payrolls, PMI hitting a 25-month low and Markit PMI falling to 52.5. First-quarter GDP is likely to carry a one-handle and concerns over recession have risen. Both the Atlanta Federal Reserve and New York Fed Live Action GDP NowCasts are clocking in at a 1.3% growth rate for 1Q19. With the yield curve flat and the Fed on hold, there is concern over the direction of the economy for the balance of 2019.

This uncertainty is showing up in the NY Fed probability of recession hitting 25% (end-Feb), up from 9% a year earlier. The Voya Multi-Asset Strategy and Solutions team’s probability hit 67%, driven by the weak nonfarm payrolls data (could be revised) and yield-curve inversion (may not mean what we think). Smoothing the payrolls over three months reduces our recession probability from 67% to 51.5%, still elevated.

Nonetheless, I’d caution that it’s too early to call a recession. The NY Fed notes that the yield-curve recession signal is more like an 80‒100 bp inversion, more extreme than what we are seeing now. What’s more, the effects of extraordinary Fed policy over the past 10 years have distorted signals from the yield curve — after all, we have no precedents for gauging the effects of quantitative easing/tightening.

At times like these it’s good to look back at what has worked in the past. The Lucas critique (named for Nobel Prize winning free-market economist Robert Lucas) notes that changing the rules of the road effectively changes the outcome of the analysis — and potentially the expected impact of an inverted yield curve. For success in the markets now it’s better to follow the data, watch what the Fed is doing and monitor the continued emphasis on market economics from the Trump administration.

Please follow U.S. leading indicators on page 68 of the Global Perspectives book.

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