As discussed in earlier posts, the preferred version of my US recession probability indicator (i.e. incorporating credit spreads) rose sharply in 2007 but peaked just short of the 50% “trigger” level. It suggested the economy would be very weak in late 2007 and early 2008 but would skirt an official recession, as determined well after the event by the National Bureau of Economic Research (NBER).

Amid widespread gloom, it may seem perverse to claim a recession is still not a done deal. However, available evidence suggests next week’s first-quarter GDP report will show modest growth, of perhaps 1% annualised, with gains in net exports and stockbuilding offsetting a further slump in housebuilding and flat consumption and business investment.

Aggregate hours worked by private non-farm employees declined at a 1.2% annualised pace in the first quarter. Allowing for trend productivity growth of 2%-2.5% pa, this also looks consistent with a small rise in output.

The consensus expects GDP to contract in the second quarter but timely coincident indicators have yet to suggest a further loss of momentum. New jobless claims have stabilised since late March, with only one recent week exceeding the 400,000 level suggestive of recession. As noted by Trim Tabs, withheld employment tax receipts also imply labour market resilience – see first chart below.

Recent further energy price gains will squeeze budgets but households are due to receive tax relief of over $100 billion – 1% of annual disposable income – starting next month. Investment will be supported by $50 billion of incentives for firms to purchase equipment in 2008.

Markets appear to be a little less certain of recession. Intrade’s contract allowing bets on the probability of two consecutive negative GDP quarters in 2008 has recently fallen back from a peak of 79%. (Two negative quarters is arguably a tougher requirement than an official recession – the NBER bases its determination on a range of indicators, not just quarterly GDP.)

For investors, whether the economy is in recession currently is less important than its position in six months’ time. The second chart updates the recession probability indicator, which is giving an “all-clear” signal for late 2008, based on recent falls in real interest rates and a steeper yield curve, which are judged to outweigh tighter credit conditions. (I have made some minor changes to the indicator to improve its historical performance. The new version would have predicted the eight recessions since 1955 with no false signals. Its recent peak remains just below the 50% “trigger” level.)

Simple models may well prove fallible in current unusual times but I continue to expect the US economy to perform better than many fear in 2008, with greater risk of disappointment in Europe. 2009 may be another story, however.