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Comment: As expansion approaches 120th month, is there reason to worry about a downturn?

Fear of an economic downturn is not unreasonable given the risks facing the US economy, but it isn’t here yet and is neither inevitable or unavoidable. Fed policymakers are certainly trying to read the data accurately and respond appropriately. Given the present economic data, they won’t find immediate reason to change course more than switching to wait-and-hold as they did at the end of 2018/early 2019.

Former Fed Chair Janet Yellen has famously said that expansions do not die of old age. Former Fed Chair Ben Bernanke added the corollary that they are murdered. The point being that the length of an expansion isn’t necessarily a sign of its imminent demise, rather that expansions usually come to an end due to exogenous events. The US economy is facing risks related to uncertain fiscal and political policy. Nonetheless, the economic fundamentals are not at all bad at present.

Fed policymakers certainly do not want to kill off an expansion with short-sighted decisions or ones that are not fundamentally grounded on solid economic data. It is a rare policymaker who will not fully acknowledge that the central bank’s decisions – while evidence-based – also rely on experience and judgment. As such, setting monetary policy is an imperfect process. Most of the time the policy prescriptions for achieving the dual mandate of maximum employment and price stability are relatively clear based on precedence. Economic shocks can have unpredictable results as to the depth and duration of any downturn. It is exceptional for the Fed to deliberately court one unless there is a severe economic ill to be addressed as was the case when former Fed Chair Paul Volcker acted to break the back of inflation. I don’t think that the Fed is making a mistake in pausing its process of removing policy accommodation, nor in failing to indulge in a knee-jerk reaction to short-term events.

The National Bureau of Economic Research (NBER) is the guardian of assigning dates to economic peaks and troughs that demarcate a recessionary period. The NBER defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”
Unfortunately, there can be a substantial lag between when the NBER announces the turning points in the economy and when these actually occurred. The NBER needs to have all the data and then analyze it properly. That takes time.

Those who watch the economy closely – markets, central bankers, politicians, etc. – can’t wait that long. They need some framework for early warning of a downturn and have to rely on a few rules of thumb that can signal a change.

Commonly, these are:
• Two consecutive quarters of negative GDP growth,
• a persistent increase in the unemployment rate of more than 50 basis points from its cyclical low,
• an inverted yield curve.

As for two consecutive quarters of negative growth, the US economy is nowhere near that. The rate of unemployment is probably scraping along the bottom of its current cycle and it would take a significant increase of somewhere around 150-200 basis points before the reading could be interpreted as anything except consistent with a solid labor market. Nonetheless, a sudden and steep increase in the unemployment rate would be an uncomfortable development no matter if it settled somewhere near a still reasonably healthy 5.0%-5.5%.

Finally, although there was an inversion of the 2-10 Year Treasury yield curve on March 22, 2019, it lasted a single day and returned to more normal readings immediately thereafter. The spread remains quite narrow in the historical context and should not be disregarded.

My personal favorite is watching the Fed’s Beige Book. Although it is not hard data, the anecdotal evidence of economic activity across the 12 District Banks is a reliable guide to turning points for the economy. On the plus side, it is one which has very little distance between when the report is issued and when the change is occurring. It doesn’t forecast the size or severity of a downturn. It does effectively sound the alarm when one has arrived and then point to when it has hit bottom. A strong indication of when the economy is slipping into recession is when the share of District Banks reporting growth slips to around 60%.

June 2019 will mark a 120th month of expansion for the US economy, matching the length of the expansion from April 1991 to February 2001. The next longest period of expansion was the 106 months between March 1961 to November 1969. As of this writing, we may well be at an inflection point. The US economy has been expanding at least modestly and at times more robustly since the end of the last recession. However, unsettled trade policy, slower global expansion, and market stresses could tip the US economy into a downturn if any one of these factors worsens significantly.
At this stage it is the intensification of risk factors that have heightened concerns about a possible recession. These should not be dismissed, but until actual ill effects are more visible and persistent, there is no immediate reason to look for a downturn.

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