Short-Term U.S. Recession Risks Receding

After the much smaller than expected trade deficit in November, it now seems likely that Q4 2006 growth will end up at more than 2%, rather than the 1-2% I previously expected.

Moreover, the probability of a recession during the first half of 2007 is now declining. Previously, most leading indicators indicated a imminent recession, with the high level of corporate profits being the only anomaly. Now, two new factors makes it unlikely that there will be a recession during the first half of 2007. First, the continued decline in oil prices will continue to boost the purchasing power of American consumers and therefore by extension personal consumption. Secondly, monetary conditions are getting more and more inflationary. Even M2 have expanded at an annual rate of 10,2% during the latest 13 weeks. As the "discontinued" but more accurate money supply measure M3 typically increases even faster, this means that M3 is probably expanding far in excess of 10%. The recent acceleration occurred, not coincidentally, shortly after the Fed decided to pause.

With the short-term boost provided by falling oil prices and accelerating money supply growth, the probability of a recession during the first half of 2007 is certainly less than 50%. That doesn't mean that America have escaped the negative effects of its imbalances, just that they have been postponed. Indeed, the extent to which the increasingly bullish short-term outlook is the result of accelerating money supply growth just means that these imbalances will be aggravated.