The Most Likely Cause Of The Next Recession...

Bill McBride at Calculated Risk has a great post up about the difficulty of recession forecasting.

One difficulty is incentives. Many on Wall Street have a persistent incentive towards optimism. On the other hand, blog/media pundits have more of a pessimism bias, since bad news sells.

McBride himself, who called the downturn and the upturn, writes: "Now one of my blogging goals is to see if I can get lucky again and call the next recession correctly."

So what will cause the next recession?

McBride thinks there are three likely causes: An exogenous event (like an earthquake), a major policy plunder (overly rapid austerity), or, and this is the most likely, Fed tightening.

And the latter he writes:

Most of the post-WWII recessions were caused by the Fed tightening monetary policy to slow inflation. I think this is the most likely cause of the next recession. Usually, when inflation starts to become a concern, the Fed tries to engineer a "soft landing", and frequently the result is a recession. Since inflation is not an immediate concern, the Fed will probably stay accommodative for a few more years.

So right now I expect further growth for the next few years (all the austerity in 2013 concerns me, especially over the next couple of quarters as people adjust to higher payroll taxes, but I think we will avoid contraction). I think the most likely cause of the next recession will be Fed tightening to combat inflation sometime in the future - and residential investment (housing starts, new home sales) will probably turn down well in advance of the recession. In other words, I expect the next recession to be a more normal economic downturn - and I don't expect a recession for a few years.

In just the past several days it feels the the collective commentariat (in the media and on Wall Street) have made a big shift. Folks like Mohamed El-Erian are talking about the end of the New Normal, and a return to the Old Normal, which is a huge call. SocGen has said we're about to see a "watershed" moment for the US economy. Deutsche Bank has called the end of the deleveraging. A big yoke is being lifted off the minds of investors and analysts, as they finally accept that the Great Financial Crisis era is coming to an end.

And if it's true that this era is coming to an end, then that means it's time to return to more traditional analysis, and thinking about when the next normal recession will be, and what will cause it. And in the past it's been the Fed that's caused recessions, and if you think we're back in the old normal, it's a solid bet that it will be the Fed again.

You can see that Fed fears are creeping back ever so slightly. Barclays said this week that by the second quarter, either the big story will be the slowdown from the tax hikes, or the beginning of serious questioning about the Fed going to the exits.

This is the direction the market's mind is going in. Crisis fading. Now time to think about traditional concerns.

SEE ALSO: The end of the crisis era is almost here >



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