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Reassessing The Probability Of A “Double Dip” Recession at Trader’s Narrative

Let’s reassess the probability of another recession by taking a look at several important economic indicators:

The Anxious Index
The Philadelphia Fed recently released this quarter’s “Anxious Index”. As you’ll recall, this is a forecast of 36 (anonymous) individuals about the next quarter’s GDP growth, or lack thereof. For more details on the survey, see the previous link.

The last time we checked in with the Anxious Index was in June when it was below 10%, implying that we had a very low chance of another recession this quarter. The second quarter results for the Anxious Index is slightly higher at 16.8%. The last time the Anxious Index increased was in the last quarter of 2008 (see chart).

As I previously mentioned, a recession arrives promptly when the Anxious Index jumps to 30% and beyond. While we can no longer scoff at the improbability of such an event, it is still not at this important threshold.

Click to see larger chart in a new tab:
anxious index long term chart Aug 2010
Source: Federal Reserve Bank of Philadelphia

While they are projecting slower growth for the economy, they still see it growing steadily. This raises the odds of a downturn but it is still not likely. The forecasters see GDP growing at just under 3% for the next 2 years.

As well, the forecasters surveyed have reduced their growth projections for the next two years. They also see slightly higher unemployment than they did last quarter but they expect a gradual reduction in unemployment - down to 9% by the third quarter of 2011.

Expectations for inflation are lower this quarter but the forecast’s consensus does not expect deflation to occur. Over the horizon, expectations of future inflation is lower but still positive. The probability of deflation in 2010 or 2011 is coming in at between 1.6% and 4.3% (depending on year and measure of inflation). Inflation expectations have held steadily over time with little change.

Business Cycle Index
According to Russell Investment’s Business Cycle Index, the US economy will claw its way back into positive territory:

Russell Business Cycle Index Jul 2010
Source: Russell Investments

The BCI shows a deep setback since April 2010, marked by weak forecasts of consumption growth, weak employment gains, and elevated quality spreads among corporate bonds.

The most likely path for the BCI calls for improvement in business cycle conditions going forward. The current level is about as low as it can get without reaching an “event horizon” at which the gravitational pull of recessionary forces would be too strong to overcome.

The WLI has suddenly become a must-watch indicator with uber-bears like Albert Edwards and David Rosenberg often pointing to it as a reason for a second inevitable decline. I’ve already written about why this is not a foregone conclusion (see: Questioning the Double Dip Shibboleths)

The most recent WLI numbers (from August 6th) show the indicator climbing to 122.4 and the growth rate improving to -9.8%. That may not sound too impressive but recall that it was basically in free fall:

ECRI WLI Aug 2010
Source: ECRI

According to the managing director of ECRI, Lakshman Achuthan: “The WLI plummeted for two months through late June before flattening out and then rising to a nine-week high. But if it turns down once again, that would signal heightened recession danger.”

Economists of Note
Turning to economists of note, Robert Shiller is concerned that unless both the Fed and Washington once again turn on monetary and fiscal policy, the persistent unemployment will drive the US economy into a double dip recession. Currently, Shiller puts the probability at 50-50%, unless immediate action is taken. But he is confident, believing that both the government and the Fed understand what is at stake.

PIMCO’s Mohamed El-Erian puts the probability at 25%. He said in a recent interview with Bloomberg: “I do not think the deflation and double-dip is the baseline scenario, but I think it’s the risk scenario.”

RGE’s Nouriel Roubini wrote recently that the “Risk of a double dip recession in advanced economies (US, Japan, Eurozone) has now risen to 40%.”

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One Response to “Reassessing The Probability Of A “Double Dip” Recession”  

  1. 1 Michael C

    Let’s pick and choose our indicators. The Philadelphia Fed dropped to -7.7. Unemployment jumped to 500,000 a many month upward increase. And let’s pick my favorite. Consumer Metrics Institute Correction Watch. Now down to a -5% plus prediction of GDP. What’s most interesting is that their information comes off of current retail sales. Far in advance of the federal government’s reports.

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