Friday, December 3, 2010

Animal spirits: collapse not imminent

With the unemployment rate at 9.8 percent, confidence continues to chug upward in what I’m afraid will be a vain attempt to regain positive territory, speaking in terms of the relationship of the unemployment rate to adaptation level.  I continue to expect the next collapse of animal spirits—the defining characteristic of a recession—to occur in about 2013.  This assumes no significant improvement in the unemployment rate.  The hopeless political situation in the United States implies that no matter who wins the next presidential election, it will be considered a defeat by the people.  Continued debt defaults, banking problems and contractionary policy will probably be thrown into the mix.  Here are the charts:


For confidence to collapse in 2013 it is sufficient that unemployment begin trending up again, regardless of any (negligible) improvement between now and then.

The yield curve plus animal spirits recession probability forecasting model continues to show no hint of a collapse of confidence in the next year (the NYFRB’s model agrees):


I have written about effect of ZIRP, Zero Interest Rate Policy, on ability of the yield curve to forecast recession.  It may be true as John Hussman points out that it might be more difficult for the curve to invert, but there is no evidence that the relationship between short and long rates has fundamentally changed in magnitude.  If we see the 10-year yield in the neighborhood of one percent, watch out.  It would take only relatively mild pressure at the short end to tip things over (yes, I am expecting deflation of many asset classes in the intermediate term):


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