December 2, 2022

News in Charts: Delaying the inevitable

by Fathom Consulting.

When are Europe and the US going to go into recession? It’s not an easy question to answer, as economists are not very good at forecasting recessions. A few years ago, we analysed the IMF’s forecasting track record. We found that, of the 469 recessions that had taken place since 1988 across 194 countries, only 13 were correctly anticipated in the World Economic Outlook (WEO) published in the October of the preceding year. Worse still, fewer than half were identified even by the October of the year in which the fall in GDP took place.

In its latest WEO, the IMF warned that global economic activity was experiencing ‘a broad-based and sharper-than-expected slowdown’. The global financial crisis and the COVID-19 pandemic aside, the IMF described its forecast for global growth as the weakest since 2001. The consensus among private-sector forecasters is now for a recession across much of Europe, with the euro area as a whole suffering two consecutive quarters of contraction, beginning this year, and the UK five consecutive quarters. For the US, it is a close call, with the median projection in the latest Reuters Poll being for near-stagnation through the first half of next year, rather than outright contraction.

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Fathom’s Global Outlook, Winter 2022, whose main points will be available to Refinitiv users via Chartbook from mid-December, sees a period of recession across all the major economies in our central scenario. The historical precedents for us are compelling. Falling real wages have pushed levels of consumer confidence in the US, the EA and the UK down to levels that in the past have always signalled recession. If that were not enough, rates of inflation in the US and the UK have reached levels from which recession had been avoided only once – in 1952. Rates of inflation in the euro area  have reached levels from which recession has never been avoided. As a net exporter of energy, the US terms of trade have improved over the past year. That puts it in a fundamentally stronger position than the EA or the UK. Put together with the fact that pandemic savings still offer some protection against falling real wages, and with the Fed acting more decisively than either the ECB or the Bank of England to get inflation under control, we feel that the US stands the best chance of avoiding recession – though we give it no more than a 1-in-3 chance.

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Of course, the data that show that recession has yet to arrive are subject to revision, and recession may already be upon us without us knowing it. The conventional wisdom has been that data revisions tend to be pro-cyclical: in a boom, initial estimates of growth tend to get revised up, and in a slump they tend to get revised down. There is a logic to this. Statistical agencies base early estimates of GDP at least in part on a survey of firms, scaled up to match the number of firms in the country as a whole. In a boom, the total number of firms will tend to be growing faster than the statistical agency’s working assumption, giving a downward bias to initial estimates of growth. In a slump, the number of firms nationwide will tend to be growing more slowly than the statistical agency’s working assumption, or perhaps falling outright, giving an upward bias to initial estimates of growth.

In our own analysis, we find evidence of pro-cyclical revisions to initial estimates of growth in the UK, but only up until the global financial crisis. Before 2010, there was a strong, positive correlation between the final estimate of the change in GDP growth from one quarter to the next. But since 2010 that correlation has gone away. In the US and the EA, by contrast, we find that pro-cyclical revisions to initial estimates of GDP growth have persisted, at least until the eve of the pandemic.

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In our Global Outlook, Winter 2022, we will argue that, while non-farm payrolls data are a lagging indicator of economic activity, their timeliness meant they might still provide a useful cross-check on whether the US has entered recession. As the chart below shows, the monthly change in non-farm payrolls tends to flip from around +240,000 in the month when activity peaks, to around ‒210,000 in the first month of recession. But the next chart, which shows a smoothed measure of revisions to the initial estimate, casts some doubt on the usefulness even of non-farm payrolls as an arbiter of recession, at least in the short term. In the period following the dotcom bust, and again during the global financial crisis, initial estimates of the change in non-farm payrolls were revised down significantly.

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Where does this leave us, in terms of the current outlook? For now, we persist in our judgment that a recession in the European single currency bloc is almost inevitable, despite the stronger-than-expected initial estimate of EA growth. Indeed, given the tendency for early estimates of EA growth to be revised pro-cyclically, it may well have entered recession in Q3. Nevertheless, signs that EA economies have managed to substitute away from Russian gas to a greater degree than we had imagined, means the recession may be less severe than we thought. We assign a greater weight to the notion that the US might escape recession. As for the UK, initial estimates suggest the economy contracted in Q3, and we expect it will do so again in Q4.

The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.

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