WHY THE ODDS OF A RECESSION ARE RISING / THE WALL STREET JOURNAL

Why the Odds of a Recession Are Rising

Indicators show a growing risk of a recession within the next year as the government shutdown saps the economy’s strength

By Justin Lahart


Internal Revenue Services employees rally against the government shutdown in Ogden, Utah, on Jan. 10. The shutdown has hurt sentiment measures. Photo: george frey/Reuters 


Even in the best of times, investors can’t dismiss entirely the risk that the U.S. will slide into a recession within the next year. These aren’t the best of times.

The government shutdown is straining the finances of federal workers and contractors, the cumulative effects of the U.S. trade fight continues to weigh, while slowing growth abroad—particularly in China—compounds those woes. Markets remain unsettled, housing’s problems have deepened and business sentiment is flagging.

All of these have lifted the red flags higher. Economists polled by The Wall Street Journal earlier this month put the chance of a recession beginning within the next 12 months at 25%— the highest since 2011.

And other recession indicators are at their highest since the last downturn. A J.P. Morgan recession forecasting model, based on economic variables, puts the odds at about 43% and a Federal Reserve Bank of New York model, based on U.S. Treasury yields, puts them at 22%.

Elevated recession odds, even at current levels, are worrisome because in the past they have often signaled a downturn. There have been false signals too, of course: The New York Fed’s model reached 33% during 1998’s financial turmoil, for example, and promptly retreated. The next year the economy boomed.

“I think of a model as one tool we use,” said J.P. Morgan economist Jesse Edgerton, who helped develop his firm’s forecasting tools. “We want to layer on some judgment on top of that.”

The partial government shutdown, for example, has hurt sentiment measures, in turn helping send recession odds higher. If it ends fairly soon, those measures should rebound.

Still, the shutdown likely has sapped the economy’s strength in the first quarter. Much of the spending federal workers and others have deferred will be made up, but not all of it. And with each additional day, the damage will intensify.

This is happening as China’s slowdown is becoming more pronounced, trade problems are constraining some businesses and the growth boost from last year’s tax cut and stimulus are starting to fade. That could be a dangerous brew for the economy.

The tight labor market is another reason the recession odds have risen in models like J.P. Morgan’s, and presents what may at the moment be an unappreciated risk. Most economists, including those at the Federal Reserve, believe the unemployment rate of 3.9% is below its sustainable level. But in the past, when the rate has risen more than a few tenths of a percentage point, it has kept rising—and a recession has followed.

None of which is to say a downturn is necessarily in the offing—the U.S. economy has proved remarkably resilient in the past decade. But anyone who thinks it isn’t facing a challenge now hasn’t been paying attention.