Risk of Recession Builds...

Discussion in 'Economics' started by S2007S, Nov 13, 2006.

  1. S2007S


    Merrill Lynch North American Economist David Rosenberg provided the following comments in regard to the probability of a recession in 2007:

    * The Institute for Supply Management's (ISM) purchasing managers' index came in at a weaker-than-expected 51.2 for October, down from 52.9 in September. The consensus was 53.0.

    * What's the "take away"? At no time in the history of the data has the index hit 51.2 in a downtrend without breaking below 50. That level is important because it is the dividing line between an expansion and a contraction in industrial activity. Experience indicates that once the index hits 51.2, it typically slides below 50 in one to three months.

    * Indeed, the ISM's chief economist said that he "would not be surprised" to see the index break 50. Once it does that, history shows that the Federal Reserve cuts rates within two months. In other words, if the past is a good guide, the Fed will be easing in March 2007 at the latest.

    * Our recession-risk indicator puts the probability that there will be an economic downturn in the coming year at 51%. That's the highest level since the 2001 recession.

    * In the past, the indicator hit 51% and did not accurately predict a recession only twice. If the model is right — and the key word is "if" — the average lead time between the first move above 50% and a recession is 12 months (the median is 10 months).

    * We currently think that GDP will grow at an annual rate of roughly 2% for the fourth quarter, and the risk is on the downside in light of the weak "handoff" in terms of macro momentum as the quarter began and what we know so far anecdotally about spending in October. Our 2007 GDP growth estimate of 2% hasn't changed, but keep in mind that our forecast assumes that the Fed will cut the funds rate to 4% next year. Without that stimulus, growth could well be closer to 1.0% to 1.5%. That would be weak enough to be in the hard-landing zone that sees a sharp reversal in the unemployment rate and the emergence of credit problems.