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Commentary: Recessions? Never consensus, always hiding in plain sight

LONDON (Reuters) - Fears that the U.S. economy is about to slip into recession have receded quite significantly in the last few days, thanks to payrolls and JayPo.

Federal Reserve Board Chairman Jerome Powell speaks during his news conference after a Federal Open Market Committee meeting in Washington, U.S., December 19, 2018. REUTERS/Yuri Gripas

A red-hot jobs report for December and Fed chief Jerome Powell’s signal that, essentially, the central bank has the market’s back, have been enough to lift some of the gloom and send Wall Street and bond yields shooting higher again.

The recent tightening in financial conditions has paused, and money markets are cooling on the idea that the Fed may be forced to cut rates this year or next. Risk assets and market sentiment around the world have rebounded too.

For now at least, Wall Street is giving Main Street the benefit of the doubt.

But recessions in the United States and across the developed world are never the consensus forecast among economists, so they always come as a surprise.

As Morgan Stanley Investment Management’s Ruchir Sharma notes, professional forecasters have missed every U.S. recession since such records were first kept half a century ago.

In August 2000 the Philadelphia Fed’s Survey of Professional Forecasters raised GDP forecasts for the first two quarters of 2001 to 3.0 percent and 2.7 percent, respectively. The recession would start in March.

The Great Recession began in December 2007. In May 2008, having already failed to spot two quarters of negative growth, the survey reported: “The forecasters do not expect a contraction in real GDP in any of the next five quarters.”

Part of the problem is ‘recency bias’: using economic forecasting models that tend to give too much weight to recent events. Groupthink and herd mentality also contribute.

It’s easy to see why there’s reluctance to predict recession: There’s often no concrete evidence for it, even if signs of a slowdown become visible. Growth in pre-recession quarters is often strong, as these two charts from Trading Economics show.

U.S. GDP growth, annual rate 1945-1983
U.S. GDP growth, annual rate 1983-2018

Annual GDP growth topped 5 percent in four consecutive quarters in late 1952 and early 1953, and six months later the economy was shrinking. Similarly, the annual rate of growth was between 4 and 8 percent in most of the quarters over 1972 and 1973 before recession struck.

In the four years comprising the 2004-07 period, the annual growth rate in almost every quarter was pretty much between 2 and 4 percent. Even just before the Great Recession hit, growth was fairly decent, on the surface at least.

Since the first quarter of 2017, the annual rate of growth in each quarter has been rising steadily. On an annualized basis, the U.S. economy grew at a 3.4 percent rate in the third quarter of last year, and the quarterly average over the past two years has been a decent 2.9 percent. No obvious sign of contraction.

The current U.S. expansion is a decade old, the second-longest in history. Any model based on recent events, therefore, would suggest it’s fairly plain sailing for the economy. No icebergs ahead.


As Nobel Laureate and New York University professor Paul Krugman points out, long periods without shocks leads to complacency. Consumers and investors start extending themselves, taking risks, taking on leverage that creates new risks.

Complacency extends to policymakers and regulators, too. Policy and regulation becomes too lax, allowing excesses to build and the seeds of the next blowup to be sown. Global debt, for example, hit a record $184 trillion at the end of 2017, according to the IMF, up 50 percent from a decade earlier.

There have been 11 recessions in the United States since the Second World War. The peak-to-trough contractions in GDP have varied hugely, from less than 1 percent in 1968-69 and 2001, to more than 5 percent in 2007-09. Some have been short, like the six months in 1980, others have lasted well over a year, like those in 1973-75, 1981-82 and 2007-09.

All have been preceded by an inverted yield curve, when the two-year Treasury yield rises above the 10-year yield. The curve is the flattest it’s been since 2007, and last month came within eight basis points of inverting.

This is a clear sign investors expect the Fed will raise interest rates further than the economy can handle. “Expansions don’t die of old age. I like to say they get murdered,” by the Fed, ex-Fed chair Ben Bernanke said last week.

The most obvious example of this was in the early 1980s when the Paul Volcker Fed jacked up interest rates to 19 percent to choke off inflation. Inflation was duly killed off - but so was growth.

According to the latest Reuters poll of economists, the risk of a U.S. recession in the next two years is now up to 40 percent. High, but not consensus. The last time such a high probability appeared in a Reuters poll was in January 2008, eight months before the collapse of Lehman Brothers.

Lehman and the global credit crunch plunged the world into its deepest financial and economic crisis since the Great Depression. Yet it’s worth remembering that that recession began in December 2007, a month before that poll, three months before Bear Stearns, and nine months before Lehman.

So even as the U.S. economy was shrinking, the consensus view was that a recession wasn’t imminent nor even on a two-year horizon. Could something similar be brewing right now? The shock plunge in service sector activity last month suggests it might.

“We’ll never be able to develop macro models capable of predicting demand-side recessions. And we shouldn’t even try,” wrote Scott Sumner, an economist and professor at Bentley University in Waltham, Massachusetts, in a recent blog post.

The opinions expressed here are those of the author, a columnist for Reuters.

About the Author

Reporting by Jamie McGeever; Editing by Hugh Lawson

The views expressed in this article are not those of Reuters News.