Gonna change my way of thinking: Is recession coming?

Summary

Recession is top of mind. This is the first installment of a two-report series to shed some light on the recession talk.

We updated our existing toolkit to predict recessions. We present a set of Probit models that generate probabilities of a recession over the next year.

Specifically, two major changes were introduced. The first change presents new methods based on the CPI to better capture today's inflation risk. The second change expands the framework's forecast horizon from 6 months ahead to 12 months ahead.

Using 50% as a threshold, our preferred Probit approach has never produced a false signal and has predicted all recessions since 1980. The 50% line was breached in Q2-2022, jumping to a 57% probability from 28% the prior quarter. Through August, the Q3 probability is 48%.

The new regressions with the CPI also signal recession. Each model with the CPI as a predictor variable showed the probability of recession surpassing 50% in Q1-2022. Furthermore, the average probability of the framework's eight regressions also crossed 50% in Q2-2022.

Given the historical accuracy of this Probit approach, a recession in the next year is more likely than not, in our view.

We do not believe the U.S. economy is in a recession at present. Our forecast calls for a recession starting in Q1-2023 with three consecutive quarters of negative real GDP growth and output growth turning positive in Q4-2023.

In addition to the Probit framework, the inverted yield curve is another popular recession predictor. The second installment of this series will evaluate the historical accuracy of different yield spreads.

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