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Jewish World Review Sept. 11, 2001/22 Elul 5761

Lawrence Kudlow

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Drip, Drip, Drip -- THE stock market swoon this summer has been telling us all along that there will be no roaring recovery in the second-half of 2001. Today's employment report, which has recession written all over it, confirms the market view.

Especially the sharp drop in hours worked, which have declined 3.1% at an annual rate so far in the third quarter. Ditto for the nearly one million plunge in household employment. Also, private non-farm payrolls have dropped 532,000 over the past five months. Manufacturing has shed a million jobs from its peak.

Are we in a recession? Well, we've been in a private sector recession for two quarters. It's a close call for an official National Bureau of Economic Research recession call; subject to revisions, real GDP in Q2 could easily be marked down into negative territory.

As for Q3 and Q4, two recession forecasting models show considerable danger. We re-estimated the New York Fed Treasury yield curve model, which uses the spread between the three-month T-bill and the 10-year note. We also estimated recession probabilities using the 4-quarter differences of the T-bill.

Results show considerable recession risk over the next three quarters, ranging around 40%, a probability that exceeds the models' pre-1990 recession warning. What's so interesting here is that the forecasting results from the Treasury spread model corroborate the gloomy stock market message.

Fortunately, recession probabilities diminish substantially to less than 10% in the second and third quarters of 2002.

However, the two-year Treasury to fed funds rate spread at the liquidity end of the yield curve has fallen back to zero after today's jobs report. As we have noted time and again, history suggests at least a 75 basis point differential if the Fed is actually in a stimulative position.

So the central bank should move its policy target rate to 2%. Optimally, they should make the 75 basis points move immediately in one fell swoop to avoid the incentive to postpone spending and investing decisions till there's a bottom in financing costs. If, however, the Fed continues their usual Chinese water torture drip, drip, drip approach, then the downturn could last well into next year.

JWR contributor Lawrence Kudlow is chief economist for CNBC. He is the author of American Abundance: The New Economic & Moral Prosperity. Send your comments about his column by clicking here.


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©2001, Lawrence Kudlow