Rosenberg on Lagged Effects of Fed Tightening, Corporate Deleveraging

David Rosenberg, chief economist and strategist at Gluskin Sheff, says the odds of a U.S. recession in 2019 are rising and are probably much higher than the consensus expects.

Speaking on Financial Sense Newshour last week, Rosenberg pointed to the New York Fed’s own recession probability index, which has been shooting straight up in recent months.

Consider Rosenberg’s Take: 2019 Recession, MMT and Negative Rates

“It's interesting, people will say, well, the New York Fed probability model is only 25%. I can breathe easy. But, normally, recessions start when that index gets between 30 and 40%. It never gets to 100%. So, if you normalize it, in fact, it's telling you that we have a three-in-four chance of seeing a recession, not next year, but this year.”

ny fed recession probability
Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results.

Yeah, but David, what about the fact that the Fed has now gone on pause? Doesn’t that give the markets and the economy more breathing room?

“Because debt rolls over with a lag, [interest rate hikes] hit the economy with lags that are anywhere between 12 and 18 months. So we're going to be seeing more of this impact over the course of the next several quarters…

If you look at the peak of the Fed funds rate they happened within a year of the recession. So if you are in the non-recession camp, you actually want the Fed to continue to raise interest rates because the day they stop is for a good reason: they see the whites of the eyes of the economy…

My research has shown me that the Fed has already over tightened this cycle. And it's not the first time that we've seen that, and that we're going to pay a price that we're seeing in the data already.”

fed funds rate recessions
Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results.

How firmly do you believe we’ll hit recession in 2019?

“I'm not saying it's 100%. I’ll call it 85%. Those odds are pretty high. This is a high conviction call and…I think we're going into the early stages and it's not going to be anything like 2008 or 2009—don’t get me wrong—but I think after this monumental debt cycle that we've had, especially in the corporate sector, we're going into the other side of that, and that the theme of this year, probably into next year is going to be one of debt deleveraging, and that will come at the expense of aggregate demand. And that's how you get the recession…

If you remember 2001 and 2002, although it was a tech wreck, from GDP terms it was actually the mildest recession in the post-World War II period… [however], the S&P 500 was still down 40% that cycle. From a real Main Street economics standpoint, although it was an official recession, it was mild. But it involves a lot of what I'm talking about right now, which is corporately deleveraging. To me, that's going to be the operative theme for the next four to six quarters.”

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