There’s a renewed danger of recession this year, and to explain why it’s worth revisiting the recent past. I have argued that we normally would have had a recession last year, but a nimble Fed was able to adjust policy in time to prevent the recession and create America’s first expansion of more than a decade.

On many occasions, Fed policymakers make contractionary errors late in a business cycle. The yield curve inversion such as occurred in March 2019 is normally a pretty good recession forecaster, but not perfect. It depends on how the Fed reacts. But just being far enough along in the business cycle that unemployment has fallen to the natural rate is likely as good a recession forecaster as the yield curve inversion, indeed they often go together.

The Fed avoided recession in 2019 because it ignored its Keynesian Phillips curve models that suggested overheating, and reduced rates three times. The Fed was looking at market indicators, not the unemployment rate. (Hmmm, who’s been suggesting the Fed be guided by market indicators?)

In early 2019, the trade war with China disrupted manufacturing and reduced the equilibrium (or “natural) interest rate. Fortunately, the Fed saw what was happening and responded. Now, in early 2020 the coronavirus is disrupting Chinese manufacturing and reducing the equilibrium interest rates. The yield curve has once again inverted (3m/10y). Let’s hope that the Fed sees what’s happening and once again responds aggressively. If so, there will be no recession. (Or we might luck out and the coronavirus fades away quickly.)

The consensus of economic forecasters (at the Philly Fed) calls for roughly 4.0% NGDP growth from 2020 Q1 to 2021 Q1. That’s 2.1% RGDP growth and roughly 1.9% inflation (using the PCE, not the deflator) The Hypermind prediction markets says 2.95%, which is quite a discrepancy.

The Philly survey of private economists has been consistently too optimistic on inflation for a decade, just like the Fed itself. But the discrepancy is presumably also due to a lower RGDP forecast at Hypermind. When I first noticed the discrepancy a few months back, I indicated that I was about halfway in between the two in my forecast. I’ll stick with that. Say 3.4% (1.7%/1.7%).

On balance, I don’t think there’ll be a recession this year. But if the Fed ignores market warnings that the equilibrium interest rate is falling, then a recession becomes much more likely. Let’s hope they pay attention. They’ve done such a nice job under Powell that it’d be a shame to see all those gains washed away.

Or as a Hollywood tough guy would say, “Nice expansion you got there Jay, it’d be a shame if something happened to it. How about 50 basis points?”