Recession guesswork is just as reliable as it sounds

The term "recession" made a big comeback in news stories and social media posts this month. Goldman Sachs Group Inc.’s chief economist Jan Hatzius was among those who formally bumped up his odds of a downturn to considerable media hoopla. But in Goldman’s assessment, the recession risks never got particularly elevated relative to normal — and now they’re falling again.

Here’s the latest note from Hatzius and company over the weekend:

After the July jobs report released on Aug. 2 triggered the "Sahm rule," we raised our 12-month U.S. recession probability from 15% to 25%. Now, we have moved it back down to 20% because the data released since Aug. 2 — including retail sales and jobless claims this week — shows no sign of recession.

Hatzius, of course, was referring to the empirical regularity discovered by my Bloomberg Opinion colleague Claudia Sahm that shows that the U.S. economy is typically in a recession when the 3-month moving average of the unemployment rate rises 0.5 percentage point from its low in the previous 12 months — as it did in the July labor market report published Aug. 2.

But like other recession rules of thumb, there was always a decent possibility that the Sahm rule’s usefulness would meet its match in the bizarro pandemic and post-pandemic economy of 2020-2024. And indeed, subsequent reports published this month on initial jobless claims and retail sales have calmed jittery nerves. Initial applications for U.S. unemployment benefits fell for a second straight week, and a separate report showed that retail sales rose in July by the most since January 2023.

Goldman’s numbers are lower than the median forecaster in a Bloomberg survey, which puts the probability of a recession in the next year at about 30%. That may seem troublingly high until you consider that it’s only slightly above the average probability of 27% written in by respondents since 2008 (or 24%, excluding actual recessions).

The median respondent in another survey by the Federal Reserve Bank of Philadelphia put relatively slim odds of an economic contraction in 2024, but sees about a 25% probability that the economy will shrink in the first quarter of 2025 (the survey results were received on or before Aug. 6, meaning they don’t account for the recent streak of reassuring developments). There’s always some non-negligible risk of a downturn in the U.S. economy from unforeseen shocks, and many people generally consider that baseline risk to be around 15%, which is consistent with the proportion of post-World War II history that the economy has been in recession. Whichever survey you consult, we’re not far from that normal.

I’m aware — as TS Lombard’s Dario Perkins pointed out this week — that there’s a false precision in the entire recession-probability practice and that some of the outlooks rely on fallible and inherently volatile market pricing. As Perkins first wrote in his funny-but-true 2020 post "Rules to Being a Sellside Economist," there’s an additional risk that forecasters may simply be motivated by fame or career advancement, clustering around probabilities that make them seem interesting enough while retaining plausible deniability if they’re wrong. Here’s the key excerpt from four years ago:

How to get attention: If you want to get famous for making big non-consensus calls, without the danger of looking like a muppet, you should adopt ‘the 40% rule’. Basically you can forecast whatever you want with a probability of 40%. Greece to quit the euro? Maybe! Trump to fire Powell and hire his daughter as the new Fed chair? Never say never! 40% means the odds will be greater than anyone else is saying, which is why your clients need to listen to your warning, but also that they shouldn’t be too surprised if, you know, the extreme event doesn’t actually happen.

I’m a little less disillusioned than Perkins. Certainly, recession probabilities should come with warning labels that say: "Danger — this has rarely worked very well in the past." But economists are not really Cassandras. History generally shows that they are pretty conservative and more likely to commit what are called Type 1 errors in recession forecasting (failing to project a recession) than Type 2 errors (projecting ones that failed to materialize). That was among the key findings of a 2018 International Monetary Fund paper titled "How Well Do Economists Forecast Recessions?" which reviewed 63 global economies from 1992 to 2014.The post-pandemic years — with their more frequent predictions of a US recession — are a noteworthy exception to this rule. Shifting recession odds in this unpredictable environment are a sign of the lack of visibility inherent to inflationary economies. That’s a challenge for economists, but it also presents opportunities for market participants who manage to navigate the swings in sentiment — as plainly apparent this month. To do so, they need to have a view on where recession probabilities are heading, whether they believe them or not.

With that in mind, I’ll still sit up and pay attention when economists make a fuss about the downside risks to the U.S. economy, but I clearly don’t think we’re there yet. Reasonable people can disagree about the exact number, but the trajectory still seems important, and there’s decent news on that front — we’ve gone from "pretty low" to "somewhat higher" to "oops, not quite that high!" And given the tremendous uncertainty implicit in recession forecasting, it still feels like we’re within spitting distance of "normal."

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners. Jonathan Levin is a columnist focused on U.S. markets and economics. Previously, he worked as a Bloomberg journalist in the U.S., Brazil and Mexico. He is a CFA charterholder.