Yield Spread, Employment Data Forecast Recession

Another ominous chart — this one via Floyd Norris of the NYT:

"The employment statistics and the bond market are combining to send out a warning that has been heard only rarely in the past two decades: A recession is coming in the United States.

The two charts show the double warning. Both charts warned of an economic downturn before the 1990 and 2001 recessions, and they are doing so again.

While each has arguably registered false warnings, they have never done so together."


As can be seen from the chart, the job warning was sent out in July 1990, the month in which the recession began. A warning of the 2001 recession arrived in July 2000, but few took it seriously.

To be sure, there have been just two recessions in two decades, which is not enough to validate any set of forecast tools. But if one arrives, there will be criticism that the Federal Reserve was too slow to cut interest rates as it ignored the threat of an inverted yield curve, and that it focused on inflation for too long.


Off The Charts: Double Warning That a Recession May Be on the Way
NYT, September 15, 2007   

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What's been said:

Discussions found on the web:
  1. Sam W. commented on Sep 15

    Hey B,

    What’s your opinion – Still thinking 50/50%?

  2. inOrlando commented on Sep 15

    If you haven’t read this months Market Observaton at CountraryInvestor.com, I highly recommend studying it.


    IMO, Brian Pretti is one of the finest and most astute writers in the non-establishment financial universe.

    One excellent point he makes (reiterates) near the end: “For now, many expecting the US to bypass an official recession point to payroll strength as a key rationale for this viewpoint, supportive of consumer spending. But the facts show us that tried and true leading indicators of payroll trends are pointing in exactly the opposite direction of strength. For now, the year over year rate of change in payroll growth is below the lows seen in the mid-cycle economic slowdowns of the mid 1980’s and 1990’s.”

    Bingo – he hits the nail on the head. This most certainly is not a mid-cycle slowdown. It’s either prolonged stagnation or the beginnings of a recession.

  3. Crush Da Bears commented on Sep 15

    If the Fed cuts aggressively (as they must) and there are higher revisions to employment numbers, it will be more appropriate comparing 2007 to 1995 than to 1991/2001 recessions.

    In 1995, S&P-500 was 500. Over the next five years it had risen 300%.

  4. Eclectic commented on Sep 15

    I’m bringing comments from an earlier topic forward because, let’s face it… Barringo could put up the Bhagavad Gita, but it’s all going to slide into a discussion of the Fed on Tuesday.


    Techy and Barringo, I think a FF cut would actually raise long rates, eventually leading to higher mortgage rates, not lower. Rehabilitation of the subprime mortgage debacle isn’t going to depend on short rates anyway, but rather on a transition into permanent financing that is still modulated in capital markets, the markets that Bernanke has said the Fed doesn’t operate in. If they cut FF, they run the risk of realizing higher mortgage rates and diminishing the opportunity to make that transition.


    To continue your quotation made in comments [entirely in brackets below] in a previous topic:

    [A poster over at Mish’s site left this.


    It elaborates on rule changes to the discount window and the ability of the FED to accept many instruments as collateral including MBS. Also note the removal of stigma related to borrowing in this manner.

    “In a situation in which the Fed exposed itself to significant quantities of iffy collateral and multiple institutions refused to honor their obligations, the Fed would be required to sell massive amounts of treasures in order to withdraw unbacked cash from the financial system, in the process drastically reducing the money supply and making an already precarious situation worse.”] End of Stormrunner comments.

    …extending into the text that immediately followed what you quoted from that source:

    “If losses were large enough and the Fed exhausted its surplus of treasuries, the temptation to rewrite Section 16 would be overwhelming. US dollars would lose their backing requirement and could be loaned into the system for nothing.” End quote.

    The reality is that Section 16 (I’m accepting definitions of the code in the piece on face value) rewrites wouldn’t just be a temptation under those circumstances… they’d be an item for e-m-e-r-g-e-n-c-y attention by Congress and the president.

    Let’s not make the assumption that such would ever be required. I hope it never is, but, in theory, one must recognize this to be the type of reaction or operation that Bernanke, sworn to his multiple mandates (I take an oath seriously, I expect you do as well) specifically had in mind when he offered Milton Friedman a tongue-in-cheek apology regarding Bernanke’s opinion of the failure of the Federal Reserve to inject liquidity during the Great Depression.

    In other words, such emergency reactions as this, and others, are generally what he likely was referring to when he made the remarks that got him tagged with the moniker ‘Helicopter Ben.’ However, as I’ve said on this blog before, if we ever need, truly need, a HB, we’d all probably be grateful for one at the time. The consequences of not having one could be so dour as to extend into: not having your local public utilities operate; not having access to good federal funds liquidity; not being able to distribute payroll, write a personal check or verify a credit card (or debit card) at point-of-sale; and other really fun-time experiences that an imaginative mind would have no problem at all extrapolating. Doomsday.

    In the extended quote above, the part that reads “could be loaned into the system for nothing” is probably a bit misleading. If such a circumstance of profound losses occurred, these funds wouldn’t likely be in the form of loans… they’d ultimately be injections needed to r-e-d-e-e-m depositors under federal deposit insurance. Such profound and extensive losses would put many banks into insolvency, and injections wouldn’t be “for nothing” but would rather be for offsetting liabilities of the government itself, to make depositors whole up to insurance limits. Yes I know – where the funds would come from would be the major problem, but they’d come because there wouldn’t be any other choice for government.

    So, this whole business of being critical of the Federal Reserve for exercising any authority they have (I’m not adequately informed of this) to take various types of collateral for loans through the discount window, that unflinching prudence might ordinarily prohibit, is a bit silly. The quality of that collateral is not entirely independent of Fed decisions itself. Quite to the contrary, the Fed could put huge amounts of it into default now if it wanted to, just with administrative decisions that would lock it up in a real liquidity dilemma that would make what’s occurred so far seem as a distant and happy time.

    Eventually either the Fed attempts to assist work-outs and de-leveraging, possibly by repo-ing collateral they might ordinarily not accept (I don’t mean pure hocus pocus collateral, or mystical CDOs of the first order or the same squared, cubed, pasteurized, homogenized or freeze-dried), or they may elect to be hard-headed and end up collectively with the other institutions of the U.S. and own the stuff outright… whatever it’s worth at that time. Which curtain would you select?

    Winston, even after all of that, I’m standing pat with my two new cards from the dealer. I need two cards. I’ve got two chances to fill an inside straight, Bernanke and Poole.

    I say no FF change. I expect the Fed to be innovative but to hold FF at five-two-five.

    Tuesday will be a fun day… one of the most anticipated days that we’ve had in months and months. I expect the next most anticipated day after that will be the next ADP Wednesday in October.

  5. Steve commented on Sep 15

    Hurray for tortured data!

  6. Peter commented on Sep 15

    Election year + Helicopter Ben’s M3 growth trumps graphs above?

    Plus, The Golden Rule.

    The “Good News” here IMO is that the change in employment is a SIX month measure, and that it may take while for the graph to hit bottom. Plus this appears to be an early indicator.

    Election years are mostly up or neutral years. See chart at top of p. 7 here:


    Plus Helicopter Ben’s Shadow M3 is soaring:


    Add it all up? No recession until after the 2008 elections IMO.

    The Golden Rule? “He/She who has the gold makes the rule!”

    PS — see comments in next article down about NFP negative divergence implications for the next downturn.

  7. John commented on Sep 15

    I don’t know why he choose the two year over the federal funds. Most people use a longer interest rate like the 10 year. Also, where he drew the line on the graph at 1.3%. Seems like it’s just kind of thrown on there. I trust 10 year over federal funds.

  8. Steve commented on Sep 15

    I don’t know why he choose the two year over the federal funds.

    It’s called torturing the data until it confesses.

  9. donna commented on Sep 15

    Oh, we know they’ll TRY to float us through next year alright. The question is, will they succeed?

    Recession at this point can only be stalled, but there will be one. Question is when.

  10. SPECTRE of Deflation commented on Sep 15

    “To be sure, there have been just two recessions in two decades, which is not enough to validate any set of forecast tools. But if one arrives, there will be criticism that the Federal Reserve was too slow to cut interest rates as it ignored the threat of an inverted yield curve, and that it focused on inflation for too long.”

    We can and should be critical of the FED for many things but being too slow to lower rates isn’t one of them. Mr. Norris misses the point entirely on thinking the FED has been too tight. Did he forget about the Greenspan Put or 1% rates? We have had our inflation. This time it came as asset inflation which allowed everyone to live well beyond their means through debt disguised as equity/liquidity.

    The mania is over for this credit bubble that took assets of all classes so high. What remains is the debt which must ultimately be paid by someone. No amount of cuts can cure this disease the FED itself has unleashed upon the world. Witness a second day of ques at Northern Rock. The modern day bank run has arrived.

  11. stormrunner commented on Sep 15

    Eclectic, thanks for the follow up. The question was largely related to your suggestion that opposed to a FFR decrease a viable alternative would be

    Eclectic said:

    3)- The Fed is still free to conduct open market operations (including via the discount window) to effect a desired level of liquidity regardless of the stated FF rate.

    I take it that even though the FED is obviously encouraging this feeding from the discount window something that was frowned upon previously mostly by industry peers as a show of weekness, that you feel the angst implied in the Mises piece is unfounded.

    I also believe a FFR cut here is premature, there simply has not been enough “pain”, yet– markets are recovering and are still positive on the year. As you suggest work arounds for current liquidity crises are being handled at the discount window which will likely be adjusted down, FFR cut will not aid housing, also I believe this would be early in the market downturn to cut by any previous standards. An attempt and failure to reflate here would project impotence as opposed to the necessary omnipotence necessary to maintain the hegemony.

    But anything can happen, crazy but somehow exciting all the same watching this unfold.

    One thing I would like to add is I find it comforting that the FED is actually held to Section 16 with regards to printing its way out of a delemma instills a degree of confidence I did not have previously.

  12. jonah commented on Sep 17

    WTF? Last time I looked the spread was positive!

  13. Kinney commented on Sep 19

    “While each has arguably registered false warnings, they have never done so together.”

    I am not a professional and am just looking at the graphs, but how do the graphs and the above statement mesh when it comes to 1994/1995?

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