2017-01-09 6pm EDT  |  #bonds #Federal Reserve #Wu-Xia #stocks

We are now about 90 months into the current economic expansion. It might seem like it is getting a little long in the tooth, but since WWII there has been three periods that were even longer (from Wikipedia):

Although some maverick market pundits are expressing concerns about the possibility of a recession, most economists are busy ramping up their economic growth expectations. The Bloomberg 2017 composite GDP forecast has risen to 2.2%, but 2018’s forecast is where the real action has been:

Trumponomics fever has swept Wall Street and economists have responded by cranking their economic forecasts for the next couple of years. Recession is the last thing on their minds.

I am not calling for an imminent recession, but the chances are considerably higher than most believe. As legendary Wall Street strategist Bob Farrell was fond of saying, “when all the experts and forecasts agree - something else is going to happen.”

If the economic data does start to slow, I suspect the knee jerk reaction from Wall Street will be to trot out all sorts of statistics about the mean time between the first rate hike and the eventual recession.

I can see the headlines already - “the average number of months from the first Fed rate hike to the onset of the recession is 33 months, so all clear sailing for another year!”

But the purpose of this post is to remind you that the Federal Reserve did not start hiking in December 2015 as most believe. No, the Fed has been tightening since the first taper.

When the Federal Reserve engaged in Quantitative Easing they pushed the effective Fed Funds rate below zero. Two PHD economists, Wu and Xia created the Wu-Xia shadow rate to measure the equivalent Fed Funds rate. According to their model, the Fed pushed Fed funds to a rate of negative 2.88% in the summer of 2014.

The Federal Reserve actually first raised rates when they tapered their quantitative easing purchases. If you use the shadow rate, the date of the first hike is advanced by more than a year to the Fall of 2014. At the same time, rates are not up 50 basis points so far, but more than 350 basis from the negative 2.88% rate.

During the past three economic cycles, the time from the first Fed rate hike to the recession averaged 3.5 years. That timing would suggest we should be looking for a recession in the spring of 2018. Funny, isn’t that when all these economists were busy predicting the economy would really start growing?

Of course these are all just averages. Given the hugely indebted nature of the global financial system, I suspect we might find the recession at our doorstep earlier than most would expect.

Just remember that when everyone starts quoting the “time from the first rate hike to recession” statistic, they will probably use the wrong starting date.

Thanks for reading,
Kevin Muir
the MacroTourist