Even before Harvey and Irma were set to punish Texas and Florida, erasing at least 0.4% GDP from Q3 GDP according to BofA and costing hundreds of billions in damages (contrary to the best broken window fallacy, the lost invested capital more than offsets the “flow” benefits from new spending, which is why the US does not bomb itself every time there is a recession to “stimulate growth”), things were turning south for the US economy, so much so that according to the latest Deutsche Bank model, which looks at economic data that still has to incorporate the Irma/Harvey effects, the risk of a recession starting in the next 12 months is near the highest it has been since the last recession.
As Deutsche Bank’s Dominic Konstam writes, at first glance, the modeled probability is admittedly low at about 8% as of the end of August (down a touch from near 10% in June), but it has been generally trending higher despite a brief post-election dip. As a result, the bank “sees appeal to buying SPX put spreads and bull flatteners in Eurodollars given the emergence of downside risks.”
How does Deutsche estimate recession risk?
“We use a probit model to estimate the probability that a recession will start in the next 12 months using the 1s10s Treasury yield curve, the unemployment rate less CBO’s NAIRU, annual core CPI ex-shelter inflation, aggregate hours worked growth, and the year-on-year change in oil prices. Unemployment’s proximity to NAIRU and soft core inflation are the key factors contributing to the appearance of some recession risk currently. Aggregate hours worked remains on a relatively healthy trend and oil prices are slightly positive year-on-year, however. While it has flattened significantly, the yield curve is also relatively steep.”
On the other hand, as we discussed two months ago when observing the imminent Y/Y contraction in C&I loans, traditionally a guaranteed leading indicator of future recessions, other metrics demonstrate a far higher recession risk:
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