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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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Tue, 07/06/2010 - 21:44 | 455909 jdrose1985
jdrose1985's picture

how about a neverending cultural crisis? (at least relative to the lifespans of many here)

the 4,000lb personal transport machine society has gotta go

Wed, 07/07/2010 - 00:51 | 456100 Jasper M
Jasper M's picture

"the 4,000lb personal transport machine society has gotta go"

To borrow a line from the late, great, Charlton Heston - 

". . . From My Cold, Dead Hands!"

Tue, 07/06/2010 - 15:24 | 455048 bugs_
bugs_'s picture

Cleveland...yes dreary, need a Miami Fed.

Tue, 07/06/2010 - 16:53 | 455353 Noah Vail
Noah Vail's picture

The people in Cleveland obviously have no windows because if they did and looked out, they'd see not a double dip but a permanent dip.

Brought to you by the same peoples who said "subprime is contained." Why bother even mention the "studies" of an outfit that is NEVER right. Find something more worthy to write about, Bruce, that wasn't.

Tue, 07/06/2010 - 20:03 | 455757 akak
akak's picture

"The people in Cleveland obviously have no windows because if they did and looked out, they'd see not a double dip but a permanent dip."

I couldn't agree more.  Indeed, this frequently used phrase of "double-dip recession" is just more Orwellian propaganda, with the implicit message that 1) what we experienced post-2007 was just a garden-variety recession, which everyonewith half a brain knows it was not, and 2) that we are currently not in a recession, or at least not fundamentally still in the same depressed economic state that we were in a year ago or two years ago; this is patently untrue, and insulting to anyone who is not a bankster and who actually has to do something productive for a living, as increasingly difficult as that is.

Tue, 07/06/2010 - 21:49 | 455916 jdrose1985
jdrose1985's picture

LOL I agree, the headline today was..."treasuries imply 16% chance of double dip" or some horse shit.

 

Riiiight. Kinda funny, everytime I'm at the inlaws and the local news happens to be on, the actors talk like we never left a recession. Every other news story is blamed on "tough economic times"

Tue, 07/06/2010 - 16:33 | 455301 Rusty Shorts
Rusty Shorts's picture

Cleveland is pure sunshine,, compared to Toledo that is.

Tue, 07/06/2010 - 18:08 | 455572 MayIMommaDogFac...
MayIMommaDogFace2theBananaPatch's picture

Same sunshine on both sides of the lake...

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