A number of indicators imply that the US is heading for an Economic Recession according to Deutsche Bank.

The bank’s analysts made this claim in a European Equity Strategy Research Presentation distributed on Tuesday, which after reviewing the evidence concluded that there is a, “30% recession probability over the coming 12 months” and leading “indicators (such as services PMIs and manufacturing ISM) are already consistent with sub-consensus growth.” Therefore, “any further weakening in these indicators would further increase the risk of a recessionary outcome.”

Deutsche’s analysts point to four key indicators that highlight the rising recession risks in the US:

  1. The US profit recession: US NIPA margins peaked in Q2 2014 and have been on a declining path for the past eight quarters. Since 1950, the average gap between a peak in margins and the start of a recession has been eight quarters (as falling margins typically lead corporates to cut back on hiring and investment);
  2. The 12-month change in the Fed’s Labour Market Condition Index (LMCI) has turned negative in August: on five out of the seven occasions this happened over the past 40 years, it signalled the onset of a recession (with an average lead of 3 months). Temp employment growth is below headline employment growth, a recessionary signal in the past;
  3. Capex growth has turned negative: US capex has fallen by 2% over the past year. Negative capex growth has been associated with US recessions in the past;
  4. Rising default rates: US speculative default rates have risen to 5.7%. Over the past 30 years, they pushed meaningfully above 5% on only four occasions, three of which turned into a full default cycle (with default rates ~10%) and a recession.

The US might avoid an Economic Recession

All of these indicators and risks are usually present in the run-up to a recession. However, the deterioration of the four indicators above might be due to temporary factors — in this case US dollar strength and the drop in the oil price.  As a result, it is the belief of Deutsche’s analysts that there could be a repeat of the 1986 ‘ghost recession’.

During 1986 all of the above factors were in place, yet the US avoided a recession as the team at Deutsche explains:

“In 1986, all four signals were in place, yet the US avoided a recession. Back then, as now, the bleak reading on these indicators was preceded by a sharp rise in the US dollar (65% between 1978 and 1985, compared to 40% now) and a major fall in the oil price (71%, compared to 75% this time round). What makes the comparison even more striking is that: a) 1986 was the only episode over the past 60 years in which US corporate margins declined (from 8.6% in Q2 1984 to 6.7% in Q4 1986) without this leading to a recession; b) it was the only episode over the past 40 years during which capex growth turned negative (driven by falling energy investments) without this leading to a recession; c) it was the only episode over the past 30 years in which speculative default rates rose meaningfully above 5% without this leading to a recession..”

Only time will tell if the 1986 playbook is suitable this time around.

Economic Recession deutsche-1
Will the US avoid another Economic Recession?