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Dec. 5, 2019, 2:18 p.m. EST

Don’t be too quick to give the economy the all-clear signal

Recession risk abates, but there are plenty of reasons to be cautious

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By Caroline Baum, MarketWatch

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An economy’s growth potential is circumscribed by the growth in the labor force and in productivity. An aging population and anti-immigrant sentiment are depressing labor force growth while we await the next technological innovation to boost output per hour worked.

Without an increase in either, the slow-growth trajectory remains in place.

Trade risks

While recession fears have abated, trade remains the big unknown. On Monday, President Donald Trump reinstated tariffs on steel and aluminum from Argentina and Brazil and threatened 100% tariffs on $2.4 billion of French imports, such as sparkling wine, cheese and cosmetics, in retaliation for France’s digital-services tax.

There’s also the prospect of additional tariffs on about $160 billion of mostly consumer goods imports from China scheduled for Dec. 15. On Tuesday, at a news conference in London, Trump said it might be “better to wait until after the election” to seal a trade deal with China.

Trump may change his tune after back-to-back triple-digit declines in the Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA -3.56%   as investors reconsidered their “trade optimism.”

Prior to this week, Trump and his minions had assured us that trade talks with China were “in the final throes” (Trump) or “down to the short strokes” (National Economic Council Director Larry Kudlow).

But there is no deal yet. And even if there were a phase-one trade deal, it would be unlikely to feature either a significant revamping of China’s unfair trade practices or a significant reduction in U.S. tariffs.

To date, China has not retaliated with trade measures in response to the signing into law last week of a bill in support of Hong Kong democracy protesters, confining its response to sanctioning human rights groups and suspending Hong Kong port access to U.S. military ships.

Still, the repercussions from trade wars remain the biggest threat to global economic growth going forward.

Message of the curve

But that’s not all. While decreasing from 38% in August, the probability of a recession in the next 12 months, based on the spread between the 3-month Treasury bill and 10-year Treasury note , stood at 25% in November, according to the Federal Reserve Bank of New York’s model.

The spread has turned more positive in the last month. But its stellar track record in predicting recession with a long lead time means the earlier inversion can’t be ignored.

Like the 3-month/10-year spread, the spread between the federal funds rate and 10-year Treasury note first turned negative in mid-May and remained inverted until the end of October.

It is highly unusual for the fed funds/10-year spread to resume its normal positive slope before the onset of recession. That’s because the Fed, which never forecasts recession, is generally slow to realize that the die has been cast.

The 3-month/10-year spread, on the other hand, does turn positive before recession begins, suggesting that the market is ahead of the curve — both literally and figuratively.

So what does it all mean? Fed Chair Jerome Powell is probably correct when he says “the economy is in a good place” — and as good as it gets — given its sub-2% growth potential , global growth slowdown, manufacturing recession and trade frictions.

And while the yield curve is no longer flashing red, it remains to be seen whether the Fed acted in time to avert the consequences an inverted curve has historically foretold: another recession.

US : Dow Jones Global
-1,032 -3.56%
Volume: 458.71M
Feb. 24, 2020 5:04p

Caroline Baum is an award-winning journalist who has been writing about the U.S. economy for three decades.

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