According to Michael Feroli and the economists at JP Morgan, based on their multi-variate model the chances of a recession before the end of 2017 now sit at 67% with the chances of recession within three years sitting at 92%.
But there’s a catch: it’s just a model.
“Accordingly, our regression models, if taken literally, now put the probability of a recession starting within three years at a startling 92%, and the probability within two years at 67%,” Feroli wrote in a note to clients on Friday. “But it is important to keep these figures in perspective.”
Feroli added that:
They reflect the simple fact that it has been quite unusual to see margin declines this large without a recession on the way. But there are also factors that [the models] do not reflect. For example, the level of margins remains quite high, suggesting there may be more room for compression than usual. And our margins measure is something of an outlier relative to our other medium-run recession indicators. If past episodes of margin compression have accompanied an overheating labour market that prompted Federal Reserve rate hikes that, in turn, caused a recession, then margins may overstate recession risk given today’s dovish Fed.
So, a bit to unpack.
The biggest indicator of recession right now is corporate profit margins.
But again, margins have been quite high for the last few years and so it’s hard to exactly distinguish between mean-reversion in the series and signs that the economy is trending towards recession.
Additionally, the Fed doesn’t look eager to ramp interest rates higher which is typically what you see ahead of recession as inflation picks up, the economy “overheats,” the yield curve inverts, and then economic growth slows.
History says that when margins fall the economy heads into recession, with Feroli noting that 9 of the last 11 times margins have fallen this far, a recession was “underway or would begin within a few years.”
And while this may well be the case again, the set-up we’re seeing is certainly a historical anomaly.
Business Insider Emails & Alerts
Site highlights each day to your inbox.