In a significant shift, our monthly recession model puts the latest probability of recession six months from now at 47 percent - down significantly from the 80 percent plus readings reported since November 2007. Confirmation of the domestic economy moving out of recession mode can be seen in the recent improvement of the LEI and the S&P 500.
Recession Probability Downshifts
In a significant turn, the probability of recession six months from now has downshifted sharply. As evidenced in the top graph, the latest probability calculation is consistent with prior economic recoveries. Our model takes a look at a very broad set of variables and these indicators suggest the current recession will likely continue through at least the third quarter of this year. This model was published in Forecasting U.S. Recessions with Probit Stepwise Regression Models, Business Economics, January 2008. Economic improvement began to show up in our model in recent months in the regional Chicago Federal Reserve manufacturing survey. While the official recovery call will come from the National Bureau of Economic Research, our outlook is that the recovery will begin in the fourth quarter led by federal government spending and a modest improvement in consumer spending.
Economy Gains While Employment Continues to Lose
While we do expect recovery in the pace of economic growth, employment remains an issue for both cyclical and structural reasons (middle graph). Job declines were widespread with major losses in manufacturing and construction. The only bright spot remaining is healthcare and education but even there gains have decreased. Another signal of weakness in the job market is the rise in the duration of unemployment. Such increases suggest that the impact on those losing jobs will be longer and more severe.
Moreover, the structural trend of declining employment in blue-collar manufacturing continues as it has since the early 1970s. These declines reflect the high cost of labor relative to capital that has prompted the increased use of technology and capital to substitute for skilled workers as well as the evolution of consumer demand from goods to services.
Employment Weakness does not Mean Spending Declines
As illustrated in the bottom graph, real personal income less transfer payments has not declined as much as employment compared to earlier recessions. This supports the case that income, which drives consumption, can recover, if even only modestly while employment continues to decline. These income gains support our view that economic recovery is likely by the fourth quarter.
In the period ahead, we expect real personal income will improve modestly in 2009 and 2010 compared to the 1.3 percent gain of last year. We expect that those income gains will boost consumer spending. Yet, we expect the recovery will not be strong enough to reproduce the housing/discretionary spending boom earlier this decade. Moreover, the recovery we expect for jobs in 2010 will also leave many disappointed.