Recession Looming?

Good post this morning on the debate over what the inverted yield curve means for economic prospects by Barry Ritholtz at . The trigger was that Arthur Laffer has been arguing that the negative yield curve does not point to an impending recession, while a story on page C1 of the Wall Street Journal came to the opposite conclusion (and Ritholtz concurs).

The most persuasive arguments from the :

Yield inversions, many analysts say, are harbingers of hard times. When bond investors see a recession coming, they tend to buy long-term Treasury securities for two reasons. First, they are safer than stocks. Second, they are appealing when inflation is low, and recessions tend to beat down inflation. The buying that comes with recession fears drives down a long-term bond’s yield, sometimes below the prevailing yield on short-term Treasury securities . . .

One economic-forecasting tool using Treasury yield-curve data pegs the chances of a recession at nearly one in two. The model, which was developed by Fed economist Jonathan Wright, takes into account yields on 10-year and three-month Treasury securities as well as the Fed’s overnight funds rate.

Another forecasting model — developed by Federal Reserve Bank of New York economists using only the 10-year/three-month spread — puts the chances of a recession in 12 months at just under 40%

And this tidbit:

Those predictions are at odds with the consensus among economic forecasters. A recent survey of economists by The Wall Street Journal pegged the chances of a recession within the next 12 months at 27%.

Economic forecasters have a terrible track record. This strong a consensus is a bearish sign in and of itself.

The comments on this post are very much worth reading, with robust arguments for and against the likelihood of a recession.

Other less than cheery news: the New York Times on Sunday that the improvement in the housing market may be a mirage:

But those who think that the worst may be over for the housing market should take another look at the data, economists say. For the figures on new-home sales have a strange wrinkle that, in the current environment, may lead the government to overstate sales (and to understate inventory) by up to 20 percent. “The market is weaker than the data say,” said Mark Zandi, chief economist at Moody’s/Economy.com.

New-home sales are tallied by the Census Bureau, based on a sampling of contracts signed by home buyers. Running at a pace of more than one million a year for the last four years, new-home sales have been a significant contributor to the housing boom — and to the economy. (Existing-home sales, reported monthly by the National Association of Realtors, count actual closings.)

But here’s the rub: If a contract to buy a home, signed in November, is canceled in December, the Census Bureau does not subtract the failed transaction from the number of sales, or add the house back to its inventory total. In the last year, as the housing market has cooled, the volume of cancellations has risen to epidemic proportions.

The Fed has signalled that it has no intention of cutting rates in the near term. Monetary conditions are very loose, and the Fed is hawkish on inflation. The memories of stagflation of the 1970s (which remember, was precipitated by defecit spending to finance Vietnam and a spike in oil prices) mean that Bernanke & Co. have a bias to strangle inflation early, rather than let things get as bad as they did then, and have to force an even sharper recession later. Not a pretty picture.

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