Test. Test. Test. Test. Test. Test. Test. Test. Test. Test. Test. Test. Test. Test. Test. Test. Captioning performed by vitac there are some well known differences in the current economic environment compared to past environments that make the yield curve a little less of an indicator. The probabilities are pretty high. If you take the unjusted measure, and the other financial variabilities, a year from now, the Second Quarter of 2020, the probability of recession is roughly twothirds. If i make an adjustment, its still high, its not far away. The shaded bars represent recessions. Every time this measure goes over 40 , weve had a recession. And theres a lot of more fundamental reasons to be a little nervous about whats going on out there and why recession risks are high. If you look globally, a number of Major Economies are already in recession or pretty close. Germany, italy, the uk, brexit is complicating things for them. Mexico, brazil, singapore, its small but most open economy on the planet and its feeling the ill affects of the trade war, korea. And here at home, theres increasing signs of recession risk. I would argue there are big parts of the economy that are already in recession. Manufacturing would be a good example. The agriculture sector, the farm belt and manufacturers and farmers ship a lot of things so the transportation distribution sectors are also arguably in recession. Now, you add up the total output of those industries, by the way, connect those industries right back to the trade war. Theyre on the front line with the trade war. And, you know, if you add up the output, its about 20, 25 of gdp. The economy can continue to move forward in the sectors are in recession. If theyre contracting, not gracefully, it can happen. If the problems in manufacturing and ag and transportation start to bleed out into the rest of the economy, then we got a problem, thats a recession. Theres some evidence of that too. If you take a look at job growth which has been key to the economic expansion, a year ago just to give you a number to give you context, take the calendar year of 2018, average monthly job growth nonfarm payroll, was about 225,000 per month. If you cut through the volatility in the data, job growth feels like its pretty close to about 100,000 a month. If thats the end of it, if we hang around 100,000, no big deal. Thats enough job growth to maintain substantial employment. But if job growth slows any further, unemployment will start to rise and well talk about this in a few minutes as well. Once unemployment starts to rise, game over, recession is very likely. So part i, recession risks are in my view uncomfortably high and rising. I didnt mean to imply too high level in the precision here. Just kind of gives you a broad sense of where we are. I dont mean to imply too high level. The recession date, that is you should take that into consideration, the exact day. Ill be quite precise. I may even give you the time of day. Part two, what as i said, recessions generally have at their core some cause. This i may be overstating the case here a little bit. Economists always want to find an explanation for things. My guess is that recessions are much more complex than that. Theres lots of moving parts and they all conflate with each other and so its probably not appropriate to say this is the reason for why a recession occurred, but we do that anyway. There is something that out there that feels like its the proximate cause for that downturn. If you go back to the Great Recession ten years ago, we had lots of problems. But the proximate cause was the sub prime mortgage problems there. If you go back to the 2000 2001 downturn, that was the technology boom, tech bubble, the equity market got overvalued and the correction there resulted in recession, along with 9 11. If you go back to the 1990 1991 recession, that was savings and loans, many of you might not remember saving and loan. They were quite a significant part of the Financial System back in the day and they failed quite significantly. They got turned upside down on their mortgage portfolios. I can go back to every recession since world war ii and theres been ten of them, and i can at least expose, identify what was behind the recession. This risk matrix gives you a sense of the kinds of risks we face and the different kinds of potential causes for an economic downturn. The x axis represents the potential severity of the event or shock. The y axis is my assessment of the probability of that shock. How likely is it . Just acclimate to yourself to the risk matrix. If you look into the northwest part of the matrix, you can see manufacturing recession. High probability event, i would argue we are in recession. But by itself, i cant put tthe broader economy into recession. The shock is relatively low. If you go into the southeast quadrant, look at the fed chair jay powell is removed, and as you know, President Trump has been railing against the fed and attacks on chair powell and has threatened to remove him, if that were to happen, that would be a big deal. It would royal financial markets. It would probably indicate a recession. I put a low probability on that. We want to focus on the shocks that are in the northeast part of the matrix. You can see the most obvious is the trade war. That is a big deal and at this point the thing that could push us in. A couple of other things to point out, i wont go into detail unless you ask, you can see nodeal brexit, also by itself, probably wouldnt push the u. S. Into recession, but obviously it would be hard to digest particularly in the current economic environment. But im going to focus on the trade war. The links between the trade war and the economy are several fold but there are two key ones. The most obvious is the higher tariffs. They are a tax on American Business and american consumers. If all of the tariffs that the president has threatened to implement are actually implemented, as you know we have a lot of tariffs already, but hes threatened to impose additional tariffs on the remaining imports we get from china by december, if he follows through on all of that, the tax bill, the increase in tariffs in 2020 will come in at around a hundred billion dollar. Just to put that into context, a hundred billion dollar is a half of point of gdp. The economy is growing about 2 . Half a point is meaningful, it means the economy would be growing below its potential, unemployment would rise. And its about half the size of the tax cut that we got last year, the remember the tax cut that is were passed at the end of 2017, implemented in 2018. Thats the reduction in corporate rates, cuts for individuals. That was about 200 billion in tax cuts in the calendar year. About half the magnitude. So those are significant. Most of the tariff increases so far have been on products that businesses use for their own production. Its not directly affecting consumers. Its not like you walk down the aisles of walmart and see the effects of the trade war there, at least not yet. But the next batch of tariffs, thats when consumers will feel it. Thats almost entirely consumer goods and at that point wed see a higher prices for the things that we buy, many things that we buy. It would be also very hard on retailers, the one part of the economy thats really also struggling also in recession but not because of the trade war is brick and mortar retailing. Obviously the online competition really doing a number on brick and mortar retailers and theyre operating on very thin margins if the tariffs are implemented and they cant pass all of that through to the consumers, that means theyll be upside down on their profitability, theyll be losing money. They have no cushion. Theyll be bankrupt and well see a lot of layoffs in the sector. The second link between the trade war and the economy and recession risks is the length that i think most economists kind of missed or at least didnt appreciate or didnt put enough weight on up until recently and that is the impact on business confidence. Business sentiment has been hammered across the globe. Big your sentiment survey, all saying the same thing, we have a survey that we conduct off of one of our websites, economy. Com that weve been doing since 2003. Its a weekly survey. Its a Global Business survey. Smooth out a little bit of the volatility, this is monthly data. In our survey there are nine questions that we ask. Im showing the results for two of those questions. The broad questions, the first one is around how do you as a business person feel about your Business Prospects as of the current point in time . Thats the blue line. And the green line is a question about expectations. How do you think things will be going in your business and broadly in the economy six months from now . This is a diffusion index. Its the percent of positive responses to the survey questions less negative responses. If it goes below zero, theres more negative responses than positive responses. And you can see a very sharp erosion in sentiment since the trade war really got going about a year were firmly negative. Im a little weird, every saturday morning, i get up, and i look at the survey results, theyre email today me. And last week, i cant wait until tomorrow morning, but last week they fell to the lowest level since the recover act was passed in february of 2009. Businesses are nervous. And its manifested in already in investment spending. Businesses have become much more caution in their Capital Expenditures especially investment spending has gone flat. This is not just in the United States. This is whats going on across the globe. In the United States its particularly telling because those tax cuts, they were supposed to juice up investment. Big argument for the tax cut in terms of longterm Economic Growth was if you lower the top marginal rate for corporations from 35 , which is where they were before the tax cut, to 21 , which where they are now, that would lower the cost of capital. You would see more investment. That would improve productivity growth. Weve got none of that. I was always skeptical of that argument. Theres none of that in the data. Just the opposite. Capital spending has gone completely flat in part because i think the tax cut is not that important in terms of investment. But also more importantly because of the trade war. And more recently this is where the recession starts to rise considerably, it does feel like businesses are becoming much more caution in their hiring. Theyre not laying off workers, thats not happening. If that were to happen, that means recession. But what we are seeing is that businesses in many parts of the economy, many industries, many regions of the country, are now becoming much more caution in their hiring. It also makes sense that they would be more cautious on investment before hiring given how tight the labor market is. The number one problem was, i cant find people. I cant find qualified workers and i cant retain my existing workers. Theres a lot of turn in the labor market. Business people are very low to cut back on their Human Resources activities. They know if they do and the trade war is over, and the economy revs back up and theyre going to lose the people that they rely on. So they decided to pull back on their investment, become more cautious on their investment before hiring and thats what were observing in the marketplace. So i think recession risks are very high and rising. Business sentiment is very week. Consumers still oblivious because they havent really felt it. If they do then, recession worries will rise. Nodeal brexit, thats a big deal. It seems like that can is getting kicked down the road. Maybe not the deadline was october 31st, now it looks like it might be january 31st, Something Else to watch. Another potential proximate cause for recession. Okay. How are you doing . Are you doing okay . All right. All right. Is this too geeky . No. Okay. Good. Ill get more geeky. No, i wont do that. Part three, the road to recession, what kinds of things should you be looking at to gauge whether recession is in train. A few things have happened that suggest recession. The best longleading indicator of recession is when the economy starts operating beyond full employment. Theres a lot of debate as to what is full employment. Id say the loose consensus, cbo, fed, other economists would say, a 4. 5 Unemployment Rate would be consistent. Once we got below 4. 5, thats when businesses started to scream. Just for a data point, were at 3. 7 on unemployment. If youre past full employment, without things like the trade war, the economy would overheat. We would wage growth would accelerate, the Federal Reserve would raise Interest Rates. Its hard to remember this. If you only go back a year ago, that was the risk. Thats what we were all concerned about. It was an overheating economy. Then we got the trade war and that changed the whole kind of narrative and what we were thinking about. The economy was on the path to overheating. Interest rates were rising, the fed was pushing up Interest Rates. The unemployment if youre past unemployment, its got to rise, right . Its got to start coming back. If you dont come back, you overheat, Interest Rates rise and you could have a recession. And by the way, there is always a proximate cause for recession but a feature of every recession is an overheating economy, when you have this dynamic. So once unemployment starts to rise, even from a very low level, that is the fodder for recession. When unemployment rises, that is signaling a lot of things going on in the economy that people are starting to feel very uncomfortable about. You and i as individuals and consumers, not just Business People, but consumers, every day americans, theyre less open jobs positions, people are getting their getting smaller pay increases, theyre not getting the bonuses they were getting. They can sense it. You can feel it in your every day life. You can sense it in the labor market. And consumers grow more cautious, Consumer Confidence weakens, they pull back a little bit on their spending. Businessing see that. You can see how we get into this selfreinforcing negative cycle thats called a recession. The best longleading indicator of recession is when you go past full employment. On average, in the ten recessions since the period in the ten recessions leading to the ten recessions since world war ii, the average length of time is about three years. We went below 4. 5 unemployment in the summer of 2017. So summer of 2018, summer of 2019, summer of 2020. Another very good longer leading indicator is weakening profitability and believe it or not, corporate profits, economiwide have not gone anywhere in the past five years. Theyve been flat as a pancake. And Profit Margins, thats the margin they get over their costs, have now been declining for almost two years. Labor costs are rising because of the tight labor market. Businesses have not been able to pass that through fully in the form of higher prices. Inflation has been relatively low. That means margins have been compressed. Theyve started to decline. When Business People see margins weakening, they become much more cautious and nervous and things like a trade war give them a lot of angst. Profit margins have been declining now almost two years, thats another good indicator that we might be on the road to recession. Probably the best, though, indicator, i mentioned this earlier, is the yield curve. It is the relationship between long term Interest Rates and short term Interest Rates. Long term Interest Rates are higher than short term Interest Rates. The obvious reason is Bond Investors, the people who buy the bonds, want compensation for the risk of investing in a bond that has a longer maturity. Things happen. If its a threemonth period, theres a lot less chance that youre going to get nailed by something, inflation or recession or whatever, compare today a tenyear period. You demand a people for that, a higher Interest Rate for that. You can upward sloping yield curve. There are times, not typical, very unusual, when the yield curve is inverted, short term Interest Rates are higher than long term rates, and that happens prior to economic downturn. What this is showing here is the difference between the yield on the ten year treasury bond back to 1975 and im showing the recessions with the shaded bars. And youll notice that prior to every recession, the yield curve inverts and its never falsely predicted. The average length of time between when this happens, when the curve inverts and recession is one year actually, its pretty narrow. A little give or take around that one year. But its one year is a pretty good gives you a pretty good sense of timing. The sercurve inverted in may. Weve been inverted, may, june, july, august, september. Its a pretty hard inversion, a long inversion. If history is any guide, that will suggest that the recession will be sometime summer of 2020. The intuition behind this, a couple of different ways of thinking about it, the first is, the bond market, Interest Rates are reflection of the collective wisdom of Bond Investors all over the world. This is folks who are putting their money where their mouth is and theyre saying, hey, i think we got a problem. Interest rates are going to be lower in the future. Therefore, theyve driven down long rates. Its it gives you a sense of what smart people not that theyre always right, clearly theyre not, but, you know, the wisdom of the crowds are pretty important here. Theyre thinking about this and theyre putting their money where their mouth is and theyre saying we got a problem dead ahead. Another intuition behind it is the shape of the yield curve is very important to the profitability of Financial Institutions because what most Financial Institutions, bank, for example, do is they borrow money short term and go out and