Wells Fargo formula shows recession looming in next 18 months

By Jeff Lazerson

11/22/17

In a recent commentary, “Is the Yield Curve Enough to Predict Recessions?” the Wells Fargo Securities team impressively wrote of a more accurate model of predicting recessions than the long-running and certainly good standby model of an inverted yield curve (when the short-term interest rates generate higher yields than long-term rates).

Wells focuses on the threshold between the Fed funds rate and the 10-year Treasury yield. In a rising Fed funds rate environment (Fed raising short-term rates), the threshold is breached when the Fed funds rate touches/crosses the lowest level of the 10-year Treasury yield in that cycle.

When this occurs, the risk of recession is significant.

The Wells paper crows that this framework has accurately predicted all recessions since 1955, whereas the inverted yield curve theory missed two recessions during that time frame.

Cutting to the chase, in this current cycle, the 10-year Treasury was at its lowest point –1.36 percent — on July 5, 2016. The current Fed funds rate of 1.25 percent will likely go to 1.50 percent in December as Wells forecasts one more rate hike this year — thus breaching the threshold.

Wells calculates an almost 70 percent chance of a recession within the next 17 months (average lead time) of that breach. The chances of a recession in a 2018 through mid-2019 are elevated, the Wells commentary states.

“Recessions start at the peak of the business cycle,” said Mark Vitner, managing director and senior economist at Wells Fargo Securities. A business cycle has “never gone longer than 8 to 10 years.”

So, if you are thinking about selling in the next few years, don’t wait. Assuming you believe the Wells Fargo prediction, put your house on the market this spring.

If you are buying another property after you sell, especially if you are buying in the million-dollar-plus range, wait. Rent for a few years to wait for prices to drop.

In the long run, I suggest you hold your property.

As long as you have cash-flow to cover your house and any rentals you might own, weather the storm. Prices eventually will rise after the recession flattening.

If you are thinking about buying now, it’s OK so long as you don’t have any plans to sell in the next five years.

Regarding refinancing, better to accept a slightly higher rate and go with a no-cost loan. Mortgage rates tend to drop nicely when recessions hits. You can do another no-cost loan at a lower rate when that occurs.

Cash-out refinancing? Don’t wait. Order your appraisal at the highest point in the market so that you can maximize the potential cash-out.

What’s up with mortgage rates?

Rate news summary

From Freddie Mac’s weekly survey: The 30-year fixed rate averaged 3.92 percent, three basis points better than last week’s 3.95 percent. The 15-year fixed averaged 3.32, actually one basis point higher than last week’s 3.31 percent.

The Mortgage Bankers Association reported loan application volume was unchanged from the previous week.

Bottom line: Assuming a borrower gets the average 30-year fixed rate on a conforming $424,100 loan, last year’s rate of 4.03 percent and payment of $2,032 was $27 more than this week’s payment of $2,005.

What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages at zero points: A 15-year at 3.25 percent, a 30-year at 3.75 percent, a 15-year agency high-balance ($424,100 to $636,150) at 3.50 percent, a 30-year agency high-balance at 4.0 percent, a 15-year jumbo (over $636,150) at 3.875 percent and a 30-year jumbo at 4.125 percent.

What I think: Today’s read is meant to assist you and yours in terms of housing, mortgage and other financial planning. It’s not meant to be a Debbie Downer as we roll over from Thanksgiving into the year-end holiday season.

If you have questions or comments, please contact Jeff Lazerson by clicking here.