Sal Guatieri, Senior Economist at BMO Capital Markets, suggests that the recent slower US growth and weakness in financial markets have pundits debating recession risks. Key Quotes “Despite slowing, the economy is not currently in recession. Among six indicators eyed by the NBER (the official judge), only industrial production and wholesale trade are below year-ago levels. By contrast, GDP, income, payrolls and retail sales continue to expand. Still, several financial conditions that often preceded recessions are flashing warning signs: • Corporate credit spreads are above historical norms, reflecting a loss of investor confidence. • Stock prices have fallen this year (down 7% y/y). • The trade-weighted dollar is at 13-year highs (10% y/y). Thankfully, other financial barometers that are often associated with expansions remain favourable: • The Treasury yield curve remains positively sloped, reflecting easy monetary policy and expected growth. The curve inverted before the last seven recessions. • House prices are rising (5.8% y/y Case-Shiller index), supporting household wealth and confidence. • Oil prices are falling (down 43% y/y), boosting spending power. Crude prices often jumped before recessions. However, recession odds will increase materially if strains in financial markets persist. Assuming credit spreads, the yield curve, the dollar, equities and oil prices remain near current levels, and house price gains moderate, the equation predicts a near 40% chance of recession in early 2017. That’s significantly larger than the typical 13% odds of a downturn, and not statistically different than even. Still, given that some of the weakness in financial markets does not appear to reflect worsening economic fundamentals, financial conditions should improve and lessen recession odds. Investors seem concerned that the dollar-led decline in exports (which accounts for just 12% of GDP) will lead to a broader decrease in domestic demand. However, consumers drive two-thirds of GDP, and given low debt-service costs, cheap fuel, and rising house prices, they should keep spending. Only one of the last ten recessions (the 2001 tech-bust) was not caused by a consumer pullback. Bottom Line: The risk of a U.S. recession in the next year is not immaterial if financial conditions remain weak. This is the main reason Fed officials are likely to delay policy normalization. However, the decline in investor sentiment appears unwarranted by economic fundamentals, and an expected improvement should greatly allay recession risks. We judge the odds of a recession in the next year to be no more than one in four.” For more information, read our latest forex news.