Vanguard’s chief economist shares his views on the U.S. economy


Vanguard Global Chief Economist Joe Davis examines the current low-growth environment and weighs the likelihood of a U.S. recession in the near future. He also considers to what degree the markets may be pricing in recession concerns.

TRANSCRIPT

Vanguard Perspectives® Noni Robinson: So, Joe, the U.S. economy hasn’t experienced a recession in about seven years. How likely do you think a U.S. recession is in the next year or so?

Joe Davis: Sure. Well, thanks, Noni. I mean, clearly, the beginning of the year, the markets were reflecting fairly high, elevated odds of recession, which, in our estimation and judgment, were somewhat overstated. And the reason for that is expansions, all else equal, just dont die of old age. They generally die of a combination of two things: imbalances in the system, such as a housing run-up and overbuilding, as well as a shock, a so-called-[shock], something that comes as an unforeseen negative that can deteriorate confidence. Right now, there would be two or three indicators that would suggest at least nontrivial odds of recession. I think that would be just the low-growth environment we have been in and we’ve talked about for a number of years. Where we’re closer to a low-growth, a zero bound, so to speak, in economic growth. So that, in itself, would raise odds. Parts of the U.S. economy are struggling—manufacturing and exports. Again, something we talked about at the beginning of the year in [Vanguard’s economic and investment] outlook, remain in place. And then, finally, just have corporate profits. They’re elevated, but they’ve started to come down, even outside of energy. And so that, at least, is a somewhat of a yellow flag in terms of a warning signal. That said, it’s hard-pressed to say right now that the odds of recession are very elevated, by our judgment certainly, roughly 15%, 20% odds. The reason why they’re so low is because we saw the Federal Reserve, despite modest tightening, still [being] very accommodative, meaning 50-basis-point Fed funds rate, well below the rate of core inflation, so very accommodative. You know, it’s hard-pressed to see a large run-up in leverage in the system, whether it’s financial leverage, or more importantly, consumer debt and so forth. Consumers, in some part, are still paying down debt in the mortgage sector. And then, finally, you just look at other imbalances. The housing market, although it’s grown, it’s still coming from very depressed levels. And so, as a share of the economy, it wouldn’t point to an outside risk of the U.S. economy tipping over. If we would tip over, I think we would be looking at shocks, very likely overseas. ‘Brexit’ is something that we will see headlines on, you know, Britain perhaps leaving the EU in the middle of the year. I think more important is China. We don’t see that emerging as a significant threat this year, as tipping the global economy to recession. But if we are monitoring an area of the world that could be recessionary [over] the next two or three years, it would be potentially from China.

Noni Robinson: And, Joe, to what extent have the markets been reflecting recession worries?

Joe Davis: Well, I think, in the beginning of the year, they were actually reflecting [these worries]. The equity market had sold off, fell over 10%. The corporate bond market spreads rose relative to Treasury securities. So, in that respect, the financial markets were pricing in at least a 30% or 40% odds of recession, much higher than we would have ascribed when we looked at those indicators in addition to economic ones. But, since that time, since we’ve had stabilization, particularly in March and into early April, those odds are now more consistent with what we would’ve put overall, which is still much lower, at say roughly 15% or so at best. So, again, markets were somewhat more pessimistic, but I think that’s not surprising just given the inherent volatility in the markets.

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