John Silvia, Chief Economist
john.silvia@wachovia.com ! 704-374-7034
Azhar Iqbal, Econometrician
azhar.iqbal@wachovia.com ! 704-383-6805 June 25, 2009
Recession Probability Drops Again—This Time to 37 Percent
In a clear sign that the economic winds have shifted, our recession model puts the latest probability of recession two quarters from now at 37 percent—down significantly from the 80 percent readings earlier this year. Confirmation of economic recovery has been seen in the recent improvement of the leading indicators and sales.
Recession Probability Downshifts in the Second Quarter Economic recovery prospects have improved. The probability of recession two quarters from now has downshifted sharply over the previous quarter (top graph). As evidenced in the graph, the latest probability calculation from our model is consistent with prior economic recoveries. Our model takes a look at a very broad set of variables, and the results suggest economic recovery is likely in six months. The original model estimates were published in “Forecasting U.S. Recessions with Probit Stepwise Regression Models,” Business Economics, January 2008. Economic improvement began to show up in our model in recent months in the regional Chicago manufacturing survey. While the official recovery call will come from the National Bureau of Economic Research, our outlook is that the recovery will begin in the third quarter of this year. Economy Gains While Employment Continues to Lose While we do expect recovery in the pace of economic growth, employment remains an issue for both cyclical and structural reasons (middle graph). Job declines have been widespread with major losses in manufacturing and construction. The only bright spot recently has been healthcare and education. Aggregate hours worked in the U.S. economy have declined in recent months suggesting continued weakness in both employment and hours worked. Moreover, the structural trend of declining employment in blue-collar manufacturing continues as it has since the early 1970s. These declines reflect the high cost of labor relative to capital that has prompted the increased use of technology and capital to substitute for skilled workers as well as the evolution of consumer demand from “goods” to “services.” Employment Weakness does not Mean Spending Declines As illustrated in the bottom graph, real manufacturing and trade sales have tentatively turned upwards and this coincident indicator suggests that the economy has begun to recover. In recent months, personal income growth has improved, even if only modestly, and therefore consumption will recover. Our outlook is that consumer spending will recover in the months ahead and support our expectation that economic recovery is likely during the second half of this year. While we expect consumer spending to improve in the period ahead, we expect such growth will be disappointing to policymakers who anticipate a return to a normal pace of growth. Moreover, we expect the recovery will not be strong enough to produce jobs as in prior recoveries nor the pace of housing/discretionary spending that we have come to expect. Slower than usual growth produces greater than expected pressures on public budgets.
Recession Probability Based on Probit Model
100% Two-Quarter Ahead Probability 100%
80%
80%
60%
60%
40%
40%
20% Two-Quarter Ahead Probability: Q2 @ 37.3% 0% 79 83 87 91 95 99 03 07
20%
0%
Nonfarm Employment
1.01 1.00 0.99 0.98 0.97 0.96 0.95 0.94
Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09
Index, December 2007 = 1
1.01 1.00 0.99 0.98 0.97 0.96 0.95 0.94
Average of Last 7 Recessions Employment
Real Manufacturing and Trade Sales
1.02 Index, December 2007 = 1 1.02
1.00
1.00
0.98
0.98
0.96
0.96
0.94
0.94
0.92
0.92
Average of Last 7 Recessions Real Manufacturing and Trade Sales
0.90 Dec-06 0.90
Jun-07 Dec-07 Jun-08 Dec-08 Jun-09
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