With the yield curve collapsing (let’s look at the big picture, not the last couple of days) and the Fed seemingly determined to pursue its shadow “third mandate” (curbing overly loose financial conditions) at the risk of tightening into an environment characterized by lackluster inflation, more than a few commentators have asked if a recession is just around the corner in the US.
Adding to the angst is the failure of the Trump administration to advance its growth-friendly agenda. It’s becoming more clear virtually by the day that between the Russia probe and a series of self-inflicted PR wounds, the White House will be hamstrung indefinitely with regard to healthcare, tax reform, and fiscal stimulus.
Indeed, with every divisive tweet, Trump effectively gives opposition lawmakers one more reason to push back against his agenda.
Meanwhile, an overheating labor market seems to suggest corporate margins may have peaked and the banks notwithstanding, the buyback bid for equities may soon give way to concerns about balance sheet health.
Throw in the fact that this expansion is already the third longest on record and one can make a reasonably compelling argument that the risk of recession has risen materially.
And while SocGen says that risk is still “extremely low,” the bank’s “concerns are growing.”
Below, find those concerns and do note that SocGen relies heavily on the assumption that tax cuts will eventually materialize to support the contention that a downturn isn’t imminent…
US recession odds remain extremely low, but concerns are growing
Current US economic expansion is the third longest. The current US business expansion that began in mid-2009 is 96 months old, making it the third longest expansion in US economic history.
With tax cuts, we are likely to see this expansion last through mid-2019 and become the longest ever in US history. Beneath this optimism, however, we are struggling with narrowing profit margins and a flattening yield curve. These factors typically occur at the later stages of a business cycle. Tax cuts are important to maintain our base-case expansion outlook through 2019.
Concerns are narrowing profit margins and Fed hikes. These two factors are major components of our Recession Probability Model. They portend low odds of a recession within the next year, but they are both moving in a disturbing direction.
Narrowing profit margins are already curbing hiring growth.
Additionally, the yield curve is flattening, and if the Fed fulfils its dot-plot guidance, the curve could flatten considerably more through 2018.
These fundamental business cycle variables are deteriorating, making the extension of the business cycle more dependent on tax cuts.
Auto and consumer credit lending offer hints of late-cycle stresses. Slowing sales of autos – a big-ticket discretionary item – along with rising auto loan repayment delinquencies are the first real sign of a slowing business cycle.