- Absence of economic imbalances argues for a milder downturn
- Limited Fed firepower suggests contraction may be protracted
If the U.S. enters a recession this year, it may end up a lot like a boring conversation at a cocktail party: painfully long and shallow.
The world’s largest economy has a host of strengths, from well-capitalized banks to financially-stable households, which should help limit the depth of a downturn should one happen. Yet with interest rates barely above zero, Federal Reserve Chair Janet Yellen and her colleagues are short of measures to lift the economy quickly out of a rut, economists say.
"If a recession were to occur, it might be shallow but somewhat more extended than the 1990 and 2001 episodes since interest rates can’t be lowered as much," said Kevin Logan, chief U.S. economist for HSBC Securities (USA) Inc. in New York.
Both those downturns lasted eight months and were mild by historical standards. Gross domestic product fell by just 0.3 percent peak to trough in 2001. It dropped 1.3 percent on that basis from 1990 to 1991.
By contrast, the 2007-09 recession was the deepest and longest since the Great Depression. It went on for 18 months and saw output plunge by 4.2 percent.
If a slump does begin this year, it “will probably look more like the 2001 or the 1990-91 recession,” said Bruce Kasman, chief economist at JPMorgan Chase & Co. in New York. "It won’t have the same kind of financial dislocations and stress that was associated with” the last one.
With the global economy looking shaky and financial markets unsettled, the chances of a U.S. downturn have risen, according to economists surveyed last month by Bloomberg. They pegged the odds of a recession over the next 12 months at 20 percent, up from 15 percent in December, based on their median estimate.
The main reason many economists are betting against a decline in GDP this year is the same one that argues against a deep drop. The U.S. is mostly free of the kinds of economic distortions that could drive output sharply lower.
"Other than an inventory overhang, the U.S. doesn’t have any big imbalances," said Peter Hooper, a 26-year veteran of the Fed who is now chief economist for Deutsche Bank Securities in New York.
Growth slowed to 1 percent in the final three months of 2015 from 2 percent in the third quarter, in part because companies pared stock building.
Housing, the epicenter of the last crisis, is far from the frothy levels that prevailed prior to that downturn. Residential construction amounted to 3.4 percent of GDP last year, nearly half its 6.5 percent share in 2005. Mortgage debt is more than $1.1 trillion lower than its record high in 2008. And while housing prices have been on the rise, they’ve only just recently recouped all the ground lost during the bust.
Consumers are in much better shape financially after spending years working off debts built up during the housing boom. That’s critical because personal consumption expenditures totaled more than 68 percent of GDP in 2015.
Delinquencies on credit cards issued by banks are near a 15-year low. The saving rate is much higher than it was at the end of the previous expansion. And workers are just starting to see signs of a pick-up in wage growth more than 6 1/2 years after the recession ended.
"For the household sector in the U.S., the underlying momentum has been great," said James Sweeney, chief economist for Credit Suisse Securities (USA) LLC.
Banks too are looking stronger. The number of financial institutions on the Federal Deposit Insurance Corp.’s so-called problem list fell below 200 in the fourth quarter for the first time in more than seven years. Total industry capital now stands at $1.8 trillion, 25 percent higher than at the end of the recession, according to the American Bankers Association in Washington.
"Banks are well prepared for any slowdown domestically or globally," said James Chessen, chief economist for the association.
There are pockets of potential weakness, of course. Kasman worries that companies will cut back on their spending and hiring in response to a squeeze on their earnings.
Profits as measured by the Bureau of Economic Analysis probably fell 7 percent in the fourth quarter of 2015 from a year earlier, he said in a Feb. 19 video posted by JPMorgan.
Perhaps the biggest risk to the economy comes from outside the U.S. Economist David Levy argues the country already is heading into a recession, dragged down by an economic breakdown in China and other emerging markets.
He sees the global economy suffering a worse downturn than it did in 2008, when output dropped by about 2 percent. While the U.S. is relatively better off than much of the rest of the world, it’s not strong enough on its own to withstand the hit from abroad, added the chairman of the Jerome Levy Forecasting Center in Mount Kisco, New York.
A big danger, according to Levy, is the Fed’s limited ability to counteract any economic weakness.
In and around the 2001 recession, the U.S. central bank cut its target federal funds rate 5.5 percentage points, to 1 percent in 2003. From 1990 to 1992, it reduced it 5.25 points to 3 percent.
The Fed’s target for the rate that commercial banks charge each other for overnight loans currently stands at just 0.25 percent to 0.5 percent after the central bank raised it in December for the first time since 2006.
"We are not positioned for something that could really throw us down very hard, but we’re also not positioned to have the same kind of policy support that we normally get when we go into recession," Kasman said.
The upshot, according to Jan Loeys, JPMorgan’s chief market strategist: The slump, if it occurs, "is more likely to be a drawn-out U, even if it’s not as deep, than a big, sharp V."