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Cleveland Fed on GDP - Dreary Outlook

Bruce Krasting's picture




 
The Cleveland Fed issued a
report
that looked at the historical relationship between
lagged GDP growth and the steepness of the yield curve. They compared
the ten-year with the three-month bill yield. They used this information
to make a probability estimate for a double did recession. Not
surprisingly, they concluded that the probability is only 10%. I would
take that bet. If anyone in Cleveland is interested, let me know.

I don’t question the Cleveland Fed’s (“CF”) analysis. If you rely on
history to predict the future then the probability of a slowdown is low.
This argument has been made by a number of pundits of late. While
historically correct, I think this is dangerous logic.

It’s not clear to me that the CF believes in the predictive capability
of steepness of the yield curve. Their caveat:

Other
researchers have postulated that the underlying determinants of the
yield spread today are materially different from the determinants that
generated yield spreads during prior decades.

When they say this they really mean, “We don’t trust these
results. There is too much “noise” in the current data. We are
publishing this to try to blunt the ton of negative media about another
recession. We want consumer sentiment to be as high as possible!”

Some reasons why the predictive powers of the yield curve may not hold
up this time around.

-Sure the yield curve is steep. That is because we have ZIRP. With
3-month bills at an 1/8th everything looks steep. The bill yields since
1960:

We have never had a period like this. We are living in a dirty float.
These are not true market rates. Nor are they sustainable without
substantial consequence. We are on steroids. The results we achieve
while on these powerful drugs should be discounted.

-The NY Fed’s 1.75T QE operations are having a continued impact. The
result is extraordinary excess liquidity. Don’t trust current bill
yields. This will change at some point.

-The yield curve that the CF relies on has collapsed of late.

-The global macro story has benefited short-term liquidity in the US for
the past six months.  This too is temporary. It may be unwinding as I
write.

-Almost all other economic indicators are telling us a different story.

-Unless Paul Krugman gets his way and we get another $500b of useless
spending the fiscal side of the equation is heading into a wall. This is
the most compelling side of the recession story.

A true double dip recession is a very rare occurrence. Once in the last
60 years. I am not forecasting one because of that. I think it is much
more likely that we are entering a period of prolonged sub par growth. I
see us bumping back and forth around zero for several more years. The
NBER will not call that a recession. It sure will feel like one.

The analysis by the CF should be tempered given the “materially different
conditions that exist today. The probability of recession is
significantly higher than they have suggested. Similarly, any forecast
of future GDP growth should be discounted. With that in mind consider
this graph from the same report:

“Projecting
forward using past values of the spread and GDP growth suggests that
real GDP will grow at about a 1.00 percent rate over the next year.”

How much should we discount the CF forecast of 1%? I would suggest about
1%. We will have very little net growth over the next eight quarters.

The CBO and the SS Trust Fund look at the longer term using growth rates
of 3%. We are going to be lucky to get a third of that. Without growth
at or near 3% our deficits will explode. Our social obligations will
overwhelm us.

A second recession will kill us. A few years of slow growth will scare
us to death.

 

 

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Wed, 07/07/2010 - 08:29 | 456278 Crab Cake
Crab Cake's picture

You're scared.

My trigger finger is getting itchy. 

Fuck this country.  Fuck the Republicans and the Democrats.  Fuck the corporations and the banks.  Fuck it all.  Burn it down.

If this is not my country, and I am not a citizen but some glorified serf, then I will not be bound by it's laws. I will not go quietly into that good night.

'Cry havoc and let slip the dogs of war.' - Antony, Julius Caesar, Shakespeare

Pistol Grip Pump - Rage Against The Machine

http://www.youtube.com/watch?v=RRkvg_LuZvk

Wed, 07/07/2010 - 02:11 | 456150 infiniti
infiniti's picture

What are the terms of the bet? Define 'recession'. What is the time frame?

Wed, 07/07/2010 - 08:28 | 456276 Bruce Krasting
Bruce Krasting's picture

Well, the bet is is on a double dip. That is something that NBER says happens. The time frame would be two years. A double dip would be two consecutive quarters of negative growth.

As I said this would be a very rare occurance. One that I am not necessarly forecasting, but one that could happen.

The CF said this was a one in ten shot. So I want 10-1 odds. So that is the bet. I was not offering this bet to anyone. I was hoping that it would be the Cleveland Fed that made the "book". I lay $100 to make a thou.

bk

Tue, 07/06/2010 - 23:25 | 456029 the grateful un...
the grateful unemployed's picture

people tend to confuse their self interest with that of their corporate overlords. a double dip recession will stop the multinationals in their tracks, and stop the government which is just a pale excuse for them to operate. but celebrate, small business will begin to pick up the slack, we will get the hell out of all the central asian hell holes, and we won't have big brudda looking over our shoulder. more positives than negatives.

Tue, 07/06/2010 - 23:46 | 456026 Variance Doc
Variance Doc's picture

Bruce,

Love following your posts!

What I find disturbing (being a professional probabilist and statistician) is the fact that predictions/forecasts are made using linear models, such as in the case above.  This boils down to "trend analysis" - a dangerous path to travel.  A trend is a very loose concept.  Just ask the sheeple buying houses in 2007.

The real necessity in forecasting is the empirical distribution (nonparametric) or as a substitute (with the usual assumptions) a theoretical (parametric) heavy tailed distribution.  We are in the far end of the heavy tail (the left side) in my opinion.  This is "the 'materially different' conditions that exist today", as noted above.

The probability of a double dip in this environment is a heavy tail phenomenon, that is, it has a much higher probability of occurring than the probability under the typical Gaussian linear model (the usual suspect).  This is given the REAL economic inputs, not the usual BS pie charts, birth/death models, etc. fed to and rebroadcasted by the MSM.

These bozos (Barry, the Beard, Timmy "100", etc.) in charge really have no idea what they are doing, let alone understand the consequences.  Scratch that, they do know what they are doing to the detriment of this country and people, in the name of a select few.

"Every normal man must be tempted at times to spit on his hands, hoist the black flag, and begin to slit throats." - H.L. Mencken

Tue, 07/06/2010 - 23:03 | 456003 miket1273
miket1273's picture

Did anyone read Rosenberg's note today?  He makes a great point about the ability of the curve to invert when fed funds are pinned at zero(ish) by using the Japanese post bubble curve as an example.  Perhaps this makes the predictive nature of the recession probability model moot.

Tue, 07/06/2010 - 20:28 | 455799 zen0
zen0's picture

Scared to death? You don't know what scared is.

Food, water, ammo.....is it enough? Never know til the last Zulu lies dying at your feet, and then maybe more will come.

Tue, 07/06/2010 - 20:27 | 455795 Nikki
Nikki's picture

Today's market action was a great tell of the futile PPT attempts to squeeze shorts.. Futures down 85 in the evening followed by a ramp job after midnight for a 195 point reversal before 8am. As the market hit +168, TBT was down. No confidence and continued flight to safety (2.9% 10year is crazy). My white collar colleagues laughed. I held my shorts, one guy sold call spreads, the other shorted commodities. Two other guys liquidated their 401ks in May. We are all laughing at this casino ponzi scheme, waiting to buy more gold and silver and go long when the fed starts pumping again.. The truth is that anyone who follows the markets see it as a pure scam and know our corporate pensions have been gambled away. Will we ever see justice done to these crooks ?.

Tue, 07/06/2010 - 20:07 | 455759 DoctoRx
DoctoRx's picture

What does the sudden 25% drop in the 10 year yield from 4% to 3% (approx) predict?

And what does a sudden 2 handle on the 10 year predict?  Strength or weakness?  "Good" deflation?  One thinks not . . .

The last time the 10 year dipped to have a 2 handle was 2008 if memory serves me well.  Not good.

The fact that the economy isn't accelerating despite ZIRP means what if one compares to Japan of the last 15 or so years?

The fact that we have zombie banks means what with reference to Japan?

Thanks, Cleveland Fed, for choosing an analogy that is so pre-Japan's post-bubble era.

Tue, 07/06/2010 - 18:54 | 455657 juwes
juwes's picture

keys to a black swan:

1.  found to be predictable only in retrospect.

2. has large impact.

3. had no precedent.

 

So when the GDP goes negative 5% and everyone screams HOW THE HELL ARNOLD! someone will say "of course that happened because bla bla bla, I'm a Mac!"

Tue, 07/06/2010 - 22:40 | 455976 Wilderman
Wilderman's picture

Prime candidate:

 

US treasury/bill market collapses before (or while) China, Japan, UK, EU zone.

 

1.  No one expects it

2.  It will have a slightly larger than normal impact

3.  Precedent?  We don't need no stinking precedent! 

Tue, 07/06/2010 - 22:32 | 455964 maddy10
maddy10's picture

+1

Tue, 07/06/2010 - 19:59 | 455749 oklaboy
oklaboy's picture

guessing it will be negative buy 12/1

Tue, 07/06/2010 - 18:47 | 455647 Buttcathead
Buttcathead's picture

looks as if Banksters are going to need an advance on thier expected bigger bonuses to keep the rally going.

Tue, 07/06/2010 - 18:39 | 455635 The Alarmist
The Alarmist's picture

Beg your pardon, but if Krugman gets his way you will still get a double dip, but the consequences will be even more distasteful.  Stimulus/QE2 is just a rufee to get us past a royal fu**ing, aka the next election and the lame duck congress that is going to push through every last bit of its destructive agenda. Party on, boys and girls.

Tue, 07/06/2010 - 22:24 | 455959 maddy10
maddy10's picture

I think what he means to say is 'we are screwed anyway, what's another 2-3 trillion down the drain' Let us try this and If somehow things muddle out we will be survivors and He can twirl his beardy moustache.

Otherwise, we all knew we were screwed back in 2007 itself- I bet my 2 cents that would be his rhetoric in 2012 if people were to still follow him in 2012.

Tue, 07/06/2010 - 18:31 | 455618 sangell
sangell's picture

I've been living in state of continous fear ever since they sent those $600 stimulus checks out in the spring of 2008. Fear has become the new normal! We are all on the financial front lines now. There are no more safe areas in the rear for cowards and public sector parasites to seek shelter.

Tue, 07/06/2010 - 19:10 | 455675 DoChenRollingBearing
DoChenRollingBearing's picture

I've been living in a state of fear since 2007...

AAAAAAhhhhhh!!!!

Tue, 07/06/2010 - 18:22 | 455597 Careless Whisper
Careless Whisper's picture

M2 up only 2% yoy. banks sitting on money in their safe t bills. no loan for you!

 

Tue, 07/06/2010 - 17:40 | 455512 RSDallas
RSDallas's picture

In every recession and every downturn Reinhart and Rogoff said that economists and fed officials always said things were "different".  I doubt it's going to be different this time either.  Repression II here we come.

Tue, 07/06/2010 - 23:18 | 456022 Amish Hacker
Amish Hacker's picture

Love it: recession + depression= repression.

Tue, 07/06/2010 - 17:33 | 455489 VK
VK's picture

Sigh, usual tape banging from the FED as usual. 

Bruce, I recommend you use the ECRI leading index which is predicting a recession or you use http://www.consumerindexes.com/index.html for real time, daily data on the depression we are going through. Things are going to get a whole lot worse.

Tue, 07/06/2010 - 17:33 | 455488 demsco
demsco's picture

Could not have summed it up better. As usual, well done and spot on. Glad I shorted some solars today... Oh, I am sure it is not THAT bad, right Leo??? LOL...

Tue, 07/06/2010 - 17:09 | 455409 kaiserhoff
kaiserhoff's picture

Real estate started this and the depression is coming on strong.  We have another 50 to 75 percent to lose in most of the country just to get to fair value based on rents, replacement costs, incomes, etc.  Big illiquid markets almost always overcorrect.

Comrade Ben has one aspect of genius.  He is wrong about absolutely everything, (and he refuses to learn from his mistakes).

Tue, 07/06/2010 - 17:04 | 455398 Mark Beck
Mark Beck's picture

They have data which disproves their historical trend correlation and then they still have confidence in it enough to make projections.

This is well, stupid.

What they should say is they cannot make any conclusions or projections based on the data.

The far more interesting research is why the current trend does not correlate. What did the researcher's really find?

Mark Beck

Tue, 07/06/2010 - 17:03 | 455394 Chartist
Chartist's picture

Let's build an aquaduct from  the great lakes to Arizona....It's been talked about before 25 years ago...it will put lots of folks to work.

Wed, 07/07/2010 - 08:29 | 456280 torabora
torabora's picture

It's possible to dam up western Canada...create a Lake large enough to double NA water supply. Let's get cracking.

Tue, 07/06/2010 - 17:12 | 455420 Shameful
Shameful's picture

If you want to put people to work the answer is simple, ban all motors.  Imagine how many people would be employed in the transportation industry if people had to carry or cart around all the products we consume.  Quite the image of a man hauling a big screen TV on his back from LA to PHX.  I daresay we could employ most of the planet!  And then as people start dropping dead from failures in the JIT system then we have more jobs for grave diggers, and less people to fill those jobs!  It's a 100% employment solution!  And as a side bonus would be far more eco friendly, Al Gore would love it.

/sarcasm

Tue, 07/06/2010 - 21:52 | 455922 jdrose1985
jdrose1985's picture

i'm afraid you're on to something resembling an inevitability here.

Oh there will still be oil, just not enough to go around for us peasants.

Tue, 07/06/2010 - 16:56 | 455379 A_MacLaren
A_MacLaren's picture

So let's see, even with all of those historical recessions as a bright red target, they still turn to an indicator, that at its highest, only yielded a less than 60% probability of the subsequent event?

Economist #1: All this data...  Hmmm, what statisitical model should we choose?

Economist #2: Let's examine our goal first.  Are we looking for an honest predictor?

Economist #3: Heavens no!  The sheeple can't handle the truth.  CONfidence will be dashed to bits.

Economist #1: Well then we better go back to the yield curve, it'll produce a flawed result.

Economist #2: Do you think they'll believe it this time?

Economist #3: We can only hope so.  Data are suggesting they've stopped believing us already.

Economist #1: What data?

Economist #3: Site traffic at ZeroHedge.com

Economist #2: Uh oh, we're fucked...

http://www.youtube.com/watch?v=P-cje17OGnQ&feature=related

Tue, 07/06/2010 - 16:55 | 455374 Shameful
Shameful's picture

There is no way to grow out. Play with the numbers. It takes an INSANE growth rate to even tread water. The CBO is using 6% and on that we are sliding into the abyss. What are the chances the US can hit 6% much less 10%+ yearly growth to keep the debt storm at bay? That kind of growth, with all the energy limitations, regulations, and structural problems, is not going to happen.

The ship is going down. Everyone should get ready for that event. May not happen this year, may not happen in the next few years, but it will happen.

Tue, 07/06/2010 - 16:55 | 455368 Panafrican Funk...
Panafrican Funktron Robot's picture

I see a bigger QE happening with straight up mass purchase of T-bills and other govt. debt by the Fed.  I think the Fed has clearly showed it's hand that they're more than willing to bloat their balance sheet; it might even be a smart thing to do in order to lessen the % drop in book value in the event of a real MBS valuation via an audit (which of course then begs the question what the book value is of the govt. assets, but that's another animal entirely), not to mention the hilariously easy gains being enjoyed by the connected banks.

Further, I think they're going to do this before November, the writing is on the wall and they have to move on this now.  Krugman spelled out what is going to happen, not what he hopes will happen, he's just talking the book.  Mind you, I absolutely disagree with this approach, but I also understand that apart from a severe event there is nothing that's going to stop them from doing it. 

Which is, of course, dollar bearish, hence the recent EUR/USD moves as an example.  FX always tells the story about a month or two before it becomes a "story". 

Tue, 07/06/2010 - 16:37 | 455312 DosZap
DosZap's picture

Bruce,

I have yet seen any indicators we have EVER got out of the Depression( call it a Recession to 17 million unemployed used to be TAXPAYERS)................hell a Recession would be grand.

Tue, 07/06/2010 - 16:30 | 455296 Chemba
Chemba's picture

It was not a recession, it is a depression.

  -- Bob Prechter

Tue, 07/06/2010 - 18:24 | 455599 Bruce Krasting
Bruce Krasting's picture

Ok. You are right. Using one set of numbers there was evidence of some improvement. But in reality there was none.

Tue, 07/06/2010 - 16:05 | 455221 Traianus Augustus
Traianus Augustus's picture

The best thing they can say about all this intervention is that it would have been much worse without it.  I say BS.  The time to pay the bar tab has come and middle class is tapped out.  Good luck trying to raise taxes to pay for all this backroom dealing. 

Tue, 07/06/2010 - 22:12 | 455946 maddy10
maddy10's picture

Hey Augustus

Didn't you hear PROF Krugman!

No need to raise taxes man! Somebody is sponsoring free lunch for us americans! why worry! go borrow and spend man!

Tue, 07/06/2010 - 16:20 | 455269 Commander Cody
Commander Cody's picture

Watch it happen live and feel the burn!

Tue, 07/06/2010 - 15:59 | 455209 Gwynplaine (not verified)
Gwynplaine's picture

I think they have a sign error in their calculations.  It should read -1% growth.  Maybe that's just what it feels like.

There should be a heat index for the economy.  Take today for instance, it's 92 F in Cleveland today but with the humidity it feels like 96 F.  We need some kind of misery index.  Maybe the folks over at the CF could take the lead on that.

Tue, 07/06/2010 - 16:04 | 455217 Thoreau
Thoreau's picture

+1 Excellent!

Tue, 07/06/2010 - 15:53 | 455178 Thoreau
Thoreau's picture

Scared to life, imho.

Tue, 07/06/2010 - 15:46 | 455148 SmalleyD
SmalleyD's picture

This is all you need to know about Cleveland - http://www.youtube.com/watch?v=ysmLA5TqbIY

Tue, 07/06/2010 - 22:10 | 455943 Hedge Jobs
Hedge Jobs's picture

great vid smalley, thanks for the laugh!

Tue, 07/06/2010 - 16:34 | 455304 Art Vandelay
Art Vandelay's picture

Awesome - pure win.

Tue, 07/06/2010 - 16:22 | 455279 Bam_Man
Bam_Man's picture

No wonder LeBron can't wait to get out of there.

Tue, 07/06/2010 - 15:56 | 455192 RockyRacoon
RockyRacoon's picture

Makes me wanna pack my bag and move on up to Cleveland.

Of course, change the name and you'd have most U. S. cities it seems.

Tue, 07/06/2010 - 15:44 | 455137 Problem Is
Problem Is's picture

Does Cleveland Really Still Have a FED?
Why? Does Cleveland still really have an economy? BAHahhahaha....

Time to Downsize the FED
Atlanta... out... St. Louis... out... Minneapolis... Please... out... Richmond with that phd ass hat out... pink slips all around...

There:
A much more lean mean dollar devaluing pimpin' machine...

Tue, 07/06/2010 - 15:43 | 455131 juno9604
juno9604's picture

lot of regional fed research is pretty good but this is silly...boston fed asked in one of it's recent research papers if

those employed by government were in less fear of losing their jobs than those employed by private industry...

and they found that...holy cow!...those in govt had very little fear of losing their jobs....no s___!

 

Tue, 07/06/2010 - 15:39 | 455113 RingToneDeaf
RingToneDeaf's picture

Dead cat bounce is over?

First I heard of it.

Naaa, jest rev up the presses, Ol' Heilo Ben.

 

Tue, 07/06/2010 - 15:32 | 455076 pros
pros's picture

actually.....

after a severe financial crisis there normally follows a severe political crisis and/or a major war.

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