Forex Investment and Currency Trading

The “R” word has been increasingly suggested as an appropriate characterization of the current situation. Some argue that without two consecutive quarters of negative GDP growth there simply cannot be a recession, while others castigate policymakers who demur from using the term as being dishonest. As is usual, the truth lies somewhere between these polar positions. As to the two consecutive quarters of negative GDP growth requirement, it simply does not exist. Perhaps the reason for this “urban legend” is that recessions generally involve two negative quarters of growth, but note that while the 2001 recession lasted from Mar – Sep’01, there were not two consecutive quarters of decline (GDP fell 0.5% in Q1, rose 1.2% in Q2, and then fell 1.4% in Q3). While the National Bureau of Economic Research does consider GDP as a comprehensive measure of activity, it also looks at a variety of other indicators, with the major ones being real personal income less transfer payments, employment, industrial production, and volume of sale of the manufacturing and wholesale-retail sectors. As to policymakers being disingenuous, calling a recession is very simply not their call; the NBER is tasked with dating recessions and can do so only after establishing that a trough in diminished economic activity has been established. Even assuming the economy has entered a recession, data only exists to suggest a cyclical top, and so publicly declaring a recession would be premature.

Case can be made for recession starting Q108
Recent paths of various indicators show trajectories similar to the run-ups to past recessions. To compare the current situation to prior recessions, it is assumed that a recession began in January 2008. Q107 Real GDP was 2.4% less than in Q108, and so the trajectory, while a bit steeper than the 4 quarters to the beginning of the 2001 recession, is very close to the average track leading up to the recessions beginning from 1957 to 1990. Industrial production in the 12 months beginning January 2007 has traced out a path very similar to the average for the 1957-1990 recessions. The path of the payrolls data in the 12 months prior to recession is less steep than the average for the 1957-1990 recessions, but is quite similar to that for the 2001 recession, including peaking the month before the recession started. Consumer confidence, which has fallen so sharply in the past year to a 26-year low, has actually traced a path fairly consistent with declines leading up to recessions since 1980.

If we’re in recession, data about to get much worse

The data suggest a potential top in economic activity, but the NBER will need to observe a “significant decline in economic activity”. On average since 1957, GDP has declined 0.73% in the two quarters after the start of a recession, although it has declined as much as 2.9% (1981). Industrial production has shown a more dramatic decline. During the eight months following the start of a recession, production fell, on average, 4.9%. In the 10 months from the start of recession, non-farm payrolls have dropped an average of 1.4%. Such a drop would translate to another 1.7mm jobs lost by Q4. One bright spot is that consumer sentiment should be nearing a bottom, as it has bottomed in the fourth month of recessions.

But the curve call remains dicey
Aggressive Fed easing in 2007-8 has caused the curve to steepen much more quickly than during either the 1990 or 2001 experiences. By the end of Jan’08, the 2s30s curve stood at 223bp, a spread reached only at the end of the 2001 recession and not until nine months after the end of the 1990 recession. However, in both prior cases, the curve experienced a temporary, significant flattening (28bp in 3 months during 1992, 49bp in six months during 2001-2), before resuming its steepening trend. The situation is more volatile this time (57bp in 2 months using month-end prices) because of the massive non-rate liquidity facilities being implemented, as well as open market operations. Consequently, with the curve trading within a downtrending channel since early-March, we will respect the trend. However, market expects that as inflation wanes, the tax rebates wear off, and the economy begins to sag again in H2’08, the market will realize the Fed needs to resume cutting, causing the curve to steepen.