Labour economists see rising recession danger in the US

Prof Blanchflower said his own recession signal – the Blanchflower-Bryson Rule – has already issued a clear recession warning based on different labour indicators.

If full recession dynamics take hold in the US, you can expect violent moves in credit spreads, with contagion through the gamut of global risk-assets from stocks, to base metals, cryptos or the Aussie dollar.

It would smother the tentative green shoots in the UK and Europe, taxing the frazzled polities of the democratic West. It would put Donald Trump in the White House. Large geopolitical matters are at stake.

Markets are of a different mind, mostly convinced that America’s all-conquering economy is again picking up speed, driven by a fiscal deficit above 6pc of GDP and a rush of capex investment tied to Joe Biden’s industrial and technological rearmament against China. “All the bears are in hibernation,” said Alexandra Wilson-Elizondo from Goldman Sachs.

I cannot help noticing that the average BBB junk bond is trading at a risk-spread of 1.21pc, the same level of compression that we saw in the final blow-off phase of the subprime bubble in 2007, when all caution was thrown to the wind.

“Almost everyone, and their dog, has given up on a US recession,” said Albert Edwards from Societe Generale. The US Conference Board has dropped its recession call, in place since mid-2022. It now expects nothing worse than stagnation this year.

Confusion over the US labour market stems from conflicting measures. Pavlovian markets are fixed on non-farm payrolls, which tot up the total number of jobs, and therefore double count people taking two jobs, some of whom are in arrears on credit and car debt, and acting under stress. The measure gives a “false positive” when trouble starts.

Crucially, it misses five million people with precarious jobs. “These marginal workers get hit first,” said Prof Blanchflower. The household survey catches this pre-recession signal much earlier.

Rising fear of unemployment is also a warning, both because it picks up what is happening at the coal face but also because it is self-fulfilling: people spend less and save more. The New York Fed has an index to measure this fear effect. It shows that confidence in finding a job over the next three months has plunged to an eight-year low (minus Covid).

The percentage of small businesses planning to hire workers is in free-fall. The Chicago Fed’s National Activity Index has been negative for several months, pointing to an economy near stall speed. “All this is dangerously reminiscent of 2007, when all around were telling me I was wrong and should give up calling that much-delayed recession,” Mr Edwards said.

You could argue that investors are anticipating the “Fed put”: heads I win; tails I also win. If the economy rolls over, the Fed will slash rates and hose markets with liquidity.

That may indeed happen, but the historical pattern is that equities fall after the Fed starts a rate-cutting cycle because it is already too late by then. Such is the pattern in every US recession for the last century, bar war and Covid.

One of the reasons this occurs is that the Fed tends to take the bait, morally outraged by the egregious behaviour of markets at the top of cycle, and there is nothing more egregious than the current parabolic rise of Bitcoin, a parasitic Ponzi scheme, of no social utility and zero value. Puritanism prompts them to pop the bubble, even if the underlying economy is wilting.

For now, market liquidity is still flowing as investors draw cash parked at the Fed’s reverse repo facility. This has dropped to $522bn from a peak of $2.7 trillion 15 months ago, offsetting the effects of quantitative tightening. This source of stimulus will peter out by June.

Interest rates stuck at 5.33pc are slowly grinding down the real economy. Note that the New York Fed’s HLW estimate of the neutral rate of interest has collapsed to 0.73pc, even lower than it was before the pandemic. Are we to conclude that Fed rates are now 460 basis points above neutral? If so, this is going to end badly.

The Fed is instead fretting about a slight rebound in inflation at the start of the year, and it has an exotic toy to play with: the multivariate core trend rate, which hones in on sticky items of inflation.

This rate jumped in January, but that is also what it did mid-2008. The Fed was so spooked by that inflation head fake that it talked up rate rises, tightening credit across the whole yield curve, just as the money supply was buckling. That policy error is what pushed the American financial system over the edge, a story told by Fed economist Robert Hetzel in the Great Recession.

US banks are (mostly) less leveraged than in 2007-08, and capital buffers are greater. That is small comfort. The risk has migrated to the shadow banking sector, where it is heavily concentrated in derivatives beyond the oversight of regulators.

It is too early to pull the trigger and sell equities. The final stock rallies of 1929 and 1999 show that markets can remain irrational longer that you can stay solvent, to borrow from that badly-burned short seller John Maynard Keynes.

But keep an eye on the Sahm Rule. If it crosses the threshold, liquidate your high-beta portfolio, retreat into core bonds and fetch a tin helmet.