A Lot of Talk About A Recession, But There Are Also A Lot of Conflicting Signals

In the last month or two there has been a lot more talk about a potential recession, but there are also a lot of mixed signals. With all that said the consumer spending number for Q3 will be out at the end of month and hopefully this will give a better indication of where the economy is headed. One major problem is that consumer spending is very difficult to predict, so as a result economist have a notoriously poor track record of predicting recessions. But, before getting all involved in whether or not a recession will occur, what if the US economy were to slide into a slow growth phase where real GDP only grows 1% per quarter for two quarters? This is not a recession, but the effects will be almost the same as if the economy had a growth rate of -1% for two quarters. From Reuters:

Recession talk is heating up as the slumping housing market threatens to shackle free-spending consumers, yet stocks remain near record highs, indicating that many investors see little cause for alarm.

Identifying recessions as they happen is notoriously difficult, but if the Wall Street bulls have it wrong, history suggests they are in for a decidedly unpleasant surprise.

The last time a U.S. recession hit as the Dow Jones industrial average hovered this close to an all-time high was July 1990, and the index promptly dropped 22 percent. As for the most recent economic downturn in 2001, the Dow peaked more than a year before the recession began.

This economic cycle is proving particularly perplexing because a key measure of economic health, the job market, has been resilient despite plummeting housing activity.

The traditional arbiter of recessions, the National Bureau of Economic Research, identified the beginning of the 2001 slump eight months after it started, far too slow to be of much use to quick-trading Wall Street.

That leaves economists relying on an unusual assortment of timely gauges in hopes of calling the downturn. The trouble is, they're giving conflicting signals.

Wall Street should be a good indicator because it reflects the state of corporate profits, although the current gains may say more about investors' faith in the Federal Reserve to keep cutting interest rates to stave off recession.

At the same time, retailers . . . . are warning of disappointing sales, painting a gloomier picture of Main Street.

A long-time favorite, the yield curve, or spread between interest rates on the 10-year Treasury note and the three-month bill, has a reputation for forecasting recessions as much as 18 months ahead.

That measure had been signaling a downturn for many months, but a surprisingly deep cut in official U.S. interest rates on September 18 stoked inflation fears and drove up rates on the 10-year note, erasing the curve's recession forecast.

Among the more obscure measures, analysts at research firm Liscio are looking at "bibliometrics," or the number of times a word is mentioned in newspaper articles. A rise in the frequency of the use of the word recession "has an excellent history of calling downturns in near real-time," they say, and there has been a dramatic spike in September.

J.P. Morgan economist Haseeb Ahmed tracks consumer confidence data measuring whether people think jobs are hard or easy to get, and notes that the difference between those two groups has narrowed considerably over the past two months. "A drop this large over a two-month period ... is unprecedented except during or in the immediate aftermath of recessions," he said.

A growing chorus of analysts argue that as goes housing, so goes the economy.

Rising real estate values left homeowners feeling flush in recent years and more confident about paying for their retirement, and many economists say that wealth effect gave a lift to consumer spending.

With new home prices for August posting their biggest year-over-year drop since December 1970 and consumer confidence on the downswing, spending is showing signs of slowing.

That doesn't bode well, considering that consumer spending accounts for more than two-thirds of the economy.

John Makin, an economist at the American Enterprise Institute in Washington, thinks a recession is likely, and points out that an initial cut in interest rates by the Fed, such as the one earlier this month, "usually coincides with the onset of a recession."

Makin also cited a recently published paper by Edward Leamer, an economist at the University of California at Los Angeles, detailing how downturns in housing and consumer durables demand have preceded eight of the last 10 recessions.

However, Leamer does not think a recession is imminent because one of his preferred indicators, manufacturing sector employment, remains positive.

"There's going to be sluggish spending on the consumer side, but that's a recipe for slow growth, not recession," Leamer said. "A recession is not sluggish growth. A recession is unwanted idleness of labor and capital. The key component of that is the labor market."

"I'm thinking more along the lines of two quarters of negative growth, because I think the Fed is on the job here," he said. "The thing that might make it last longer is the fact that there's so much spending and borrowing that has been contingent on rising house prices, so if they persist in falling it could be longer."