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Outlook

Recession Not in Cards, for Now

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May 11, 2017

S&P’s Outlook: recession will remain at bay unless the unexpected arrives

Thurs Dev Issues viewer smallThere are those who say the US’s economic expansion, which began soon after President Obama took office in 2009, is approaching record length and that a downturn is inevitable. And then there are those who see the expansion continuing until something unexpected happens to pull the rug out from underneath. Put Standard & Poor’s into the second camp.

“While we anticipate the world’s biggest economy will continue to mature on its expansion path in the coming quarters, we remain of the opinion that ‘economic expansions don’t die of old age,’” the rating agency said a recent report titled, “US Business Cycle Barometer.”

S&P sees a 20% to 25% risk of recession in the economy in the next 12 months, by which time it will have tied for being the second longest US economic expansion on record. The agency noted that the economy running “too hot for too long” can result in imbalances that ultimately lead to a correction, but currently it doesn’t see that outcome in the cards. Instead, an end to the current cycle is more likely to come, for example, from the Fed tightening rates too aggressively, in reaction to real or perceived overheating.

Factors such as employment, corporate earnings, industrial production and manufacturing and trade sales—called “coincident indicators” by S&P--illustrate that the economy is not overheating in historical terms, according to the report.

“Our estimate of GDP output gap—a broad measure of the current state of the economy—puts the amount of slack in the economy currently around 1% of potential GDP, indicating that the cyclical expansion still has some room to run,” the report says.

Leading indicators, meanwhile, point to growth continuing in 2017. Private sector investment, S&P says, will be the primary driver of a pick up in economic activity this year, helping dissipate the remaining slack in the economy. Monetary and fiscal policies will also play a role. The rating agency notes that the Federal Reserve’s monetary policy remains accommodative of “cyclical expansion by the traditional Taylor Rule standard,” and assuming there are no surprises the central bank will move to a more neutral stance by year-end.

S&P describes the key risks to expansion as the “usual suspects”: The Fed tightening monetary policy more than warranted, a sudden demand shock that can’t be corrected by monetary policy, or an implosion of the financial cycle that brings down the global economy. The report says the risk to expansion from a negative shock to final demand has receded due to a recent pick up in economic activity. However, the Fed is walking a perilous line between hiking rates too much or too little, either leaving the economy weakened and vulnerable to negative shocks.

“Meanwhile, too little tightening sets the stage for significant imbalances and inflation expectations that are unmoored from the 2% anchor,” the report says, adding, “But if the Fed can hold that line, it will extend the life of this expansion and maximize employment over the medium to long run.

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