Has this shit gone on long enough?
That’s the question Jan Hatzius and crew set out to answer in a note dated Wednesday.
Needless to say, there are very real questions about when this cycle is going to turn. Amusingly, there seem to also be questions about whether this cycle will ever turn. Which is another way of asking the following absurd question: will stocks ever correct, or will Jeremy Siegel’s new target be “Dow 86,457“?
The quandary in all of this from the Fed’s perspective is of course the question of what to trust or, perhaps more poignantly, what to act on: a labor market that’s quite clearly close to overheating, or still tepid inflation.
That is, do you launch a series of Trump-ish “preemptive” tightening strikes to counter the overheating labor market or do you hold off and wait for “realized” inflation to move sustainably above target?
And speaking of Trump, what happens to inflation if he dumps $1 trillion in fiscal stimulus atop an already overheating economy? Isn’t it likely that would do a whole helluva lot more to stoke inflation than it would to bolster growth?
Part and parcel of this multi-faceted debate is the question posed here at the outset which, when stripped of the trademark (and obligatory) Heisenberg profanity is this (via Goldman):
The current business expansion has already lasted 95 months and is now the third-longest in US history. If it continues through June 2019, it will claim the top spot from the 1991-2001 expansion. Is this likely?
Below, find the bank’s answer.
The current business expansion has already lasted 95 months, which makes it the third-longest in US history according to the NBER database covering 33 business cycles back to 1854. Only the expansions from March 1991 to March 2001 (120 months) and from February 1961 to December 1969 (106 months) were longer. What is the likelihood that the current expansion will claim the top spot?
We can generate a simple answer via a slightly modified version of our cross-country recession model, which is estimated using data for 20 advanced economies since 1980. We define a recession as a quarter in which the year-over-year growth rate in real GDP per capita is negative. This criterion provides an intuitive classification of the business cycle, and it implies recession dates similar to the more judgmental NBER methodology for the case of the US. Our model says that recession risk at the 1, 5, and 9-quarter horizon is well explained by lagged GDP growth, the slope of the yield curve, equity price changes, house price changes, the output gap, the private debt/GDP ratio, and economic policy uncertainty.
Exhibit 1 shows the implied risk of recession over time at the 1-, 5-, and 9-quarter horizon for the United States. The good news is that, according to the model, there is a two-thirds probability that the expansion will live to be the longest on record; more specifically, the risk of recession over the next 9 quarters is estimated at 31%, roughly in line with the unconditional historical average. The likelihood that the expansion will break the prior record is consistent with our long-standing view that the combination of a deep recession and an initially slow recovery has set us up for an unusually long cycle.
The bad news is that medium-term recession risk is now rising. The main reason, according to the model, is that there is no longer a significant amount of spare capacity in the US economy. In fact, Exhibit 2 shows that the output gap from FRB/US—our measure for overall resource utilization in the model—now shows output to be 0.7% above potential. Moreover, further increases in utilization would continue pushing up recession risk fairly quickly. Starting from the current level, the model implies that another 1% of GDP of spare capacity would push medium-term recession probabilities up by roughly 10 percentage points.
The results reinforce our view that Fed officials will need to lean more forcefully against further above-trend growth. They have lifted the funds rate three times and seem to have pulled forward their plans for balance sheet normalization relative to earlier market expectations, but this has not yet prevented financial conditions from easing significantly. To reverse this and bring about a slowdown in output and employment growth to a trend pace, we expect an ultimate increase in the funds rate that goes well beyond current market pricing, including two more hikes in 2017 and a terminal rate of 3¼%-3½%.