NY Fed Model: No Chance of a Double-Dip in 2011
The New York Federal Reserve updated its "Probability of U.S. Recession Predicted by Treasury Spread" today with treasury yield data through June 2010, and the Fed's recession probability forecast through June 2011 (see top chart above). The NY Fed's Treasury model uses the spread between the yields on 10-year Treasury notes (3.2% in June) and 3-month Treasury bills (0.12% in June) to calculate the probability of a U.S. recession up to twelve months ahead (see details here) using the spread between those two yields (3.08% in June, see bottom chart above).
The Fed's model (data here) shows that the recession probability peaked during the October 2007 to April 2008 period at around 35-40%, and has been declining since then in almost every month. For June 2010, the recession probability is only 0.06% and by a year from now in June of next year the recession probability is only slightly higher, at only 0.18% (less than 1/5 of 1%).
According to the NY Fed Treasury Spread model, the chances of a double-dip recession through the middle of next year are essentially zero, see earlier CD post here.
20 Comments:
The data are limited to post 1960 interest rates. The 2007-2009 recession was unlike any period since 1960 because it was the first financial panic since 1929. Financial panics were more common in our nation's past, and the economic response coming out of these panics are different than our standard recessions. For example, in 1936, short term interest rates (3 mo gov treasuries) ranged from 0.11-0.20%. Long term government interest rates (10 yrs+) ranged from 2.59-2.78%. This was a very positive yield curve in 1936. Based on the formula used in the link you provided, this said their was a 0.7% chance of recession in 1937. Depite the positive yield curve, there was a very sharp contraction in 1937-1938. Today's interest rates are not much different than 1936. 3-mo treasuries have ranged from 0.05-0.16% in the past year and the 10 year note is currently yielding 3.2%. Like 1937, we still have a good chance for a second dip.
Before the economy recovered to its previous economic output level, secondary recessions followed the panic of 1929, 1893, and 1837. Another way of saying this is that for half of our past major financial panics (1837, 1857, 1873, 1893, 1907, 1929), we had a double dip. That sounds more like a 50% chance than a 0.2% chance.
hawg-
agreed.
we are currently seeing the sharpest decline in real M3 since ww2. that is what one would expect from an inverted yeild curve, not a steep one.
this bolsters my confidence that the "natural" or "functional" yield curve is being masked.
there is no way that if the functional yield curve were so steep that we would be seeing a monetary contraction.
something here doesn't add up.
One big difference to 1936 - In 1932 Herbert Hoover increased marginal rates from 25% to 63%. Then FDR later increased 63% to 79%. Then add Smoot Hawley and it was a made in Washington crisis.
We now the the "calvary coming oner the hill" and a crushing defeat for democrats and their horrible economic policies on Nov 2!!! That will be very bullish for the economy.
another thing perhaps worthy of consideration (and i do not know the answer):
do these "double dips" tend to occur more frequently in situations where we have not yet climbed back to the pre-recession GDP level?
do such dips have a different profile with regard to the yield curve? (like 1937?)
this seems like interesting ground for inquiry as perhaps what we are calling double dips are really just false recoveries (akin to bear market rallies).
if such were the case, it would seem to raise doubts about the spread model's ability to spot a second downturn. the problem is the paucity of recent double dips with the only serious one being 1982. however, it is worth noting that the fed model did NOT see that one coming until it was already happening. it put the liklihood of a double dip at nearly zero, just as now.
the same was true in 1974 and 1960.
this model has a lousy track record as a leading indicator.
morganovich,
Good point on declining M3 like an inverted yield curve. A positive yield curve is only stimulative if people borrow more money. Right now that is not happening. Consumer debt is dropping, and mortgage debt is dropping.
Getting the old data from previous financial panics is difficult. There isn't much bond data from 1894.
I agree, there's almost no chance of a double-dip within a year. However, when will growth accelerate?:
Boston Fed’s Rosengren: Growth Slowing, Deflation Is Emerging Risk
.
July 13, 2010
The core inflation rate is right around 1%,” he said. “Given the amount of substantial excess capacity that we have in the economy, there is some risk of further disinflation.
If you look at final sales — which is just taking inventories out of GDP — final sales only grew by 0.8% in the first quarter and that is after two previous quarters that averaged below 2% as well.
BEA
Gross Domestic Product: First Quarter 2010 (Third Estimate)
Real final sales of domestic product -- GDP less change in private inventories -- increased 0.8 percent in the first quarter, compared with an increase of 1.7 percent in the fourth.
Second-quarter growth looking softer
July 14, 2010
Macroeconomic Advisers lowered its second-quarter forecast from 3.2% on Monday to just 2.1% on Wednesday after weak reports on international trade, retail sales and business inventories. Moody's Economy.com lowered its forecast from 2.9% to 2%. JP Morgan went from 3.2% to 2.2%. Barclays Capital cut its estimate from 3.5% to 3%.
"Consumer spending has lost momentum," wrote Chris Christopher, a senior economist for IHS Global Insight. "The consumer is troubled by high and persistent unemployment rates, reduced values of residential properties, tight credit, and high debt burdens."
"The economy can expand in a mediocre range of 2.5% to 3.5% for a long time," Stanley said. "However, that sort of growth is not close to enough to dig the economy out of the massive hole created by the 2007-09 recession."
Do factors like housing and jobs figure prominently in the NY Fed's modeling?
empire state manufacturing survey is out this morning and is very disappointing with levels dropping dramatically since may. (though still slightly positive)
http://www.newyorkfed.org/survey/empire/Empire2010/empiresurvey_20100715.html
"Growth of Business Activity Slows
The general business conditions index remained positive but fell from 19.6 to 5.1 in July, indicating that conditions had improved at a significantly slower pace than in June. The index has fallen a cumulative 27 points from the 2010 peak of 31.9 reached in April"
there sure are a lot of indicators of a dramatic slowdown for a time with essentially zero chance of recession.
You note that the chances of recession were at their maximum from Oct. 2007-spring of 2008. Here is what the Fed (with their magical recession detector) said in the minutes of their December 2007 meeting:
"In their discussion of the economic situation and outlook, participants generally noted that incoming information pointed to a somewhat weaker outlook for spending than at the time of the October meeting. The decline in housing had steepened, and consumer outlays appeared to be softening more than anticipated, perhaps indicating some spillover from the housing correction to other components of spending. These developments, together with renewed strains in financial markets, suggested that growth in late 2007 and during 2008 was likely to be somewhat more sluggish than participants had indicated in their October projections. Still, looking further ahead, participants continued to expect that, aided by an easing in the stance of monetary policy, economic growth would gradually recover as weakness in the housing sector abated and financial conditions improved, allowing the economy to expand at about its trend rate in 2009. Participants thought that recent increases in energy prices likely would boost headline inflation temporarily, but with futures prices pointing to a gradual decline in oil prices and with pressures on resource utilization seen as likely to ease a bit, most participants continued to anticipate some moderation in core and especially headline inflation over the next few years. "
If that's what they said when their magical recession predictor was at it's height, why should we believe what they're saying now?
"We now the the "calvary coming oner the hill" and a crushing defeat for democrats and their horrible economic policies on Nov 2!!! That will be very bullish for the economy." - Soaringeagle
I believe the Democrats will get crushed in November, but it doesn't solve our problems. Following the panic of 1893, the Democrats were crushed in the 1894 midterms. They lost 125 House seats (worst defeat in history). Even with Republicans in control of Congress, the economy did not begin to recover until late 1897.
Back in " Bolt Won't Return to High-Tax UK Until 2012" you say "if you tax something, you get less of it."
We're about to cream the economy with lots of new taxes. From what you say, I'd expect to get less of it.
Homeowners lost around $7 trillion in market value between 2006 and 2010. During that period only around $300 billion of mortgage debt was paid off.
In May, pending home sales fell by around 30% to an 11 year low and without the tax credit new demand is likely to stay weak for quite some time. Consumers are in trouble and the states and federal government are running massive deficits.
While it is possible to avoid a crash for a while and that we could see a short recovery the headwinds are too strong. We require the liquidation of malinvestments before a true recovery can take place.
Let us also note the inconsistency in Mark's positions. He is very optimistic about the economy even as he is suggesting that energy prices will stay low. But we have seen that the supply side is having major problems and that we are unlikely to see oil production levels reach 2005 levels. That means that any recovery will be held back by rising energy prices.
Vangel,
Barry Ritholtz had a very good article today on the $4 Trillion in debt that still has to be digested in the housing market.
http://www.ritholtz.com/blog/2010/07/the-4-trillion-dollar-question-2/
As in the case of past financial panics, when there is a significant debt-asset bubble like this, it takes a while for the economy to work through it. It often involved a double dip depression (1837-1842, 1893-1897, 1929-1938).
While the NY fed model shows no double dip (a model that clearly missed the 1937 depression), several other indicators are clearly flashing a recession. One is the Michigan consumer index. Today's reading was 66.5 which is at a level that at this stage of a recovery cycle has always either indicated the economy is in a recession or one is pending.
The second indicator is the ECRI weekly leading index. The current reading is -9.1. Every time the reading has been beow -7, the economy had a recession (6 for 6).
It should be obvious that a single factor, the US treasury yield, cannot be reliable predictor of a large and complex economy.
This kind of pseudo math is very counter productive and very unhealthy.
It should be obvious that a single factor, the US treasury yield, cannot be reliable predictor of a large and complex economy.
Yet we have a secretive group of men and women at the Fed and Treasury who use monetary and fiscal policy to manipulate these rates. Theirs is that fatal conceit held by all central planners.
Barry Ritholtz had a very good article today on the $4 Trillion in debt that still has to be digested in the housing market.
http://www.ritholtz.com/blog/2010/07/the-4-trillion-dollar-question-2/
Thanks. I had briefly looked at the article but went over it again in a bit more detail after your posting.
While I am a housing bear in real terms, I can see a major problem that the pessimists are ignoring. It is possible for the underwater mortgage issue to go away once the currency dies in a hyper-inflationary episode. Of course, under those circumstances people are going to have much bigger problems to worry about.
I have a tendency to look at things a little differently than most of the analysts. The way I see it, real wealth and capital have not changed much because of the crisis. All that we have seen is a change of valuation that is more reflective of reality and that is not a bad thing. I have no idea why periods during which reckless gamblers who take a lot of risk to make extraordinary gains while savers and prudent investors fall behind are considered the good times. My preference is for unhampered markets that allow the players to set more realistic price levels based on a sustainable reality.
"While I am a housing bear in real terms, I can see a major problem that the pessimists are ignoring. It is possible for the underwater mortgage issue to go away once the currency dies in a hyper-inflationary episode. "
Vangel, while hyperinflation may do away with the underwater mortgages, mortgage rates would go through the roof making homes unaffordable for people to buy. The graph that was not included in Barry's article is long term home prices to income. This graph shows home prices are still above the historical norm relative to income. Since these things go in cycles, it is quite possible to see this number drop well below the historical average. High interest rates will help drive this ratio down meaning lower home prices relative to income.
"Vangel, while hyperinflation may do away with the underwater mortgages, mortgage rates would go through the roof making homes unaffordable for people to buy. The graph that was not included in Barry's article is long term home prices to income. This graph shows home prices are still above the historical norm relative to income. Since these things go in cycles, it is quite possible to see this number drop well below the historical average. High interest rates will help drive this ratio down meaning lower home prices relative to income. "
I disagree. Someone with a fixed mortgage rate that would not reset for a year or so would see the value of their outstanding amount collapse within that period. A friend of mine tells a story about his grandfather in Austria selling off a few properties and holding the mortgage paper on them. In a few years the outstanding mortgage amount was insufficient to purchase a dozen eggs or a loaf of bread.
Hyperinflation is a dangerous and corrosive problem so it makes sense to be prepared for it. If it does not happen that would be fine. But if it does it will be the opportunity of a lifetime for those few who kept their eyes open to the possibilities.
Some of the comments on this thread need to be discussed. Morganovich's comments about the functional yield curve being masked are pertinent to today. There is high financial stress and tightening spread with historically low T rates. Without QE would the spread be inverse? This dashboard says a lot: www.econpi.com.
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