Wednesday, September 4, 2019

"Recession" Narratives

Following up from my recent WSJ op-ed with Andy Puzder, "Recession Fears Are Overblown" from two weeks ago (where we outline reasons why yield curve inversion may be a broken recession indicator [Fed balance sheet weighing on the long-end, T-bill issuance pushing up short-rates, and foreign pension demand amid negative yielding foreign debt] and why macroeconomic conditions continue to be strong [unemployment below 4%, GDP growth above 2%), here is an interesting graphic I put together which depicts the recent "recession" narrative: there has been a decline in Google search traffic for "recession" since the initial 10-year/2-year yield curve inversion on 08/14/2019 (when Google searches for "recession" spiked). Interestingly it very closely follows what a Kermack-McKendrick type model predicts:

Prediction market recession odds from PredictIt were also up at the time of the yield curve inversion as well and have remained somewhat anchored there. Betters were paying to receive a near 46% chance of a recession by 2020—which is above the 21% historical mean a recession occurs over any 1.5 year period implied by the historical 15% post-war average probability a recession happens in a given year. Those elevated prediction market recession probabilities have fallen slightly to around 40% (this also assumes prediction markets are unbiased estimators and don’t pay some hedging premium etc). It’s interesting to note how the simple breach of a single financial folktale rule-of-thumb, that being the 10s2s yield curve inversion, could alone be so influential in generating generate a massive media narrative surrounding recession that semi-permanently increases recession expectations (the 10-year minus 3-month yield curve first inverted back in March 2019–not to say that’s in any way a better indicator; our WSJ piece argues they are both broken). Interestingly, U.S.-based Google searches for "recession" spiked in 2008 ahead of the Great Recession. All very fitting given the upcoming release of Bob Shiller’s “Narrative Economics: How Stories Go Viral And Drive Major Economic Events” to be released October 1.