Risks Are Elevated, But Recession Not Most Likely Outcome

A string of disappointing economic reports has heightened recession concerns.

Weakness in manufacturing activity is a particular worry. For instance, the latest Purchasing Managers’ Index, compiled by the Institute for Supply Management, suggests that the manufacturing sector is now contracting. There is additional concern that weakness in manufacturing is spilling over into the economy’s larger service sector. Though still expanding, service-sector activity has clearly lost some momentum. Meanwhile, growth of both payrolls and consumer spending has also slowed. International trade has weakened, and owing largely to tariff- and trade-policy uncertainties, capital spending by businesses has fallen. On top of that, some financial market data, such as the Treasury yield curve, are flashing recession signals.

It is hardly surprising then, that economic forecasting organizations have been busy raising their estimates of recession probabilities for the coming 12 months, or so. A perusal of a number of such published estimates indicates a range of around 20% to 35%. Taking such estimates at face value, the recession risk is quite substantial, but it is not 100%, and a better outcome is more likely.

There is no question that economic growth has slowed. However, the 3.1% growth rate experienced in the first quarter of 2019 was well above trend and was not going to be maintained in any case. Third-quarter growth will probably be fairly weak (1.5 to 2%), in part due to adjustments that overshoot, as output and demand regress toward trend (a little above 2%) and temporary impediments such as the 737 MAX grounding, the GM strike and tariff issues take a toll.

Looking ahead, the odds favor an improvement in growth. Interest rates are low, and the Fed may yet make another rate cut this year. A subsequent rate increase is unlikely before late 2020. Fiscal policy will also provide support, first to private demand from the 2017 tax cuts and second through government spending due to the 2019 bipartisan compromise federal-budget legislation. Consumer spending will likely soon rebound due to a still-strong labor market and high levels of consumer sentiment, while business fixed investment will likely respond thereafter. Absent a significant adverse external event, the best bet is for real economic growth to be close to trend over the coming year.