In this note I address the issue of where we are in the US business cycle and what comes next. My bottom line is that the pieces are falling into place for a (mild) recession sometime in the middle of 2020. The approach that I take is to line up the current expansion (which this month became the second longest ever) with the 7 other post-1960 expansions.

1. Page 1
May 16th, 2018
US BUSINESS CYCLE TIMING
Suttle Economics Notes #37
• The decline in the unemployment rate, to 3.9%, takes us into late-cycle territory
• In my central scenario for the economy, the pieces fall into place for a recession in 2020H1
• Corporate caution has dominated this expansion; it will keep the next recession mild
• Tighter financial conditions will result from the Fed, but an oil shock is also a risk
8 post-1960 expansions (NBER definitions)
1) Mar 61-Dec 69; 2) Dec 70-Nov 73; 3) Apr 75-Jan 80;
4) Aug 80-Jul 81; 5) Dec 82-Jul 90; 6) Apr 91-Mar 01; 7)
Dec 01-Dec 07; 8) Jul 09 to present.
We are in the later stages of the 8th
US business cycle
expansion since 1960. The longest expansion was the
one that began in March 1991, at the end of the first
Gulf War, which lasted 120 months. May is the 107th
month of the current expansion, which officially
makes it the second longest on record.
The unemployment rate serves as the best and most
timely indicator of overall business cycle conditions.
So long as it is stable-to-declining, the expansion is
proceeding (Chart 1). The April reading of 3.9% has
been exceeded on a sustained basis only during the
long, overheating expansion of the 1960s. In the last 3
complete expansions, the unemployment rate has hit
a cyclical low about 12-18 months before the onset of
recession. Subsequent to this low, the unemployment
rate has levelled off before beginning to rise again. An
increase in the unemployment rate from the cyclical
low of ½% point has served as a reliable signal (both
necessary and sufficient) that a recession is underway.
A stylized view of the late-cycle
The right way to think about a late cycle phase is that
it means that the economy is running out of room to
grow at a robust, above-trend pace. In such an
environment, the probability of running into a variety
of capacity constraints goes up, which can mean a
mix of accelerating inflation, a squeeze on profit
margins, a deteriorating external imbalance or some
combination of all three. One of the most important
features of a late-cycle environment is that monetary
policy becomes more restrictive, as policymakers
become concerned about overheating risks—either
through inflation or some financial excess (often
associated with asset price excesses and property
speculation). The prevalence of late-cycle conditions
does not mean that the economy is guaranteed to tip
into recession in the short-term, but such a risk is
intensified. Some kind of financial shock (either
through the stock market or through the oil price) is
then enough to tip the balance of the economy down.
3
4
5
6
7
8
9
10
11
0 12 24 36 48 60 72 84 96 108120
61 70
75 80
82 91
01 09
Chart 1
US unemployment rate
% of labor force
months of expansion
-7
-5
-3
-1
1
3
5
0 12 24 36 48 60 72 84 96 108120
61 70
75 80
82 91
01 09
Chart 2
Real wages
avg hourly earnings deflated by CPI; %oya
months of expansion

2. Page 2
May 16th, 2018
The late cycle phase of 2018-20
I see the current late-cycle phase playing out in the
following way. This is my central forecast, with plenty
of two-sided risk. Political considerations aside (a big
uncertainty), I think we about two years away from the
onset of the next recession (i.e. about mid-2020). I
expect the unemployment rate to decline further
through 2018, to a low below 3.5%. Growth should
average about 3% over this period. Inflation (core PCE
deflator) will drift up, to about 2.3%oya by 18Q4 and
the Fed will tighten once a quarter. Growth will then
slow through 2019 as fiscal stimulus fades; monetary
policy is tightened; and corporates remain cautious.
Inflation will edge up even as growth slows (in part,
because of USD weakness).
Inflation heading to 2.5%oya in 19Q4 will be enough
to keep the Fed in action (another four hikes in 2019),
even as growth slows. The Funds rate would end 2019
at 3.375%, and cumulative tightening from the low
will have been 325bp. This compares to a cumulative
350bp (1994 to 2000) and 425bp (2004-06) in the last
two tightening cycles. As has become usual, the Fed
will stop tightening ahead of the onset of recession. It
will likely do so as the unemployment rate begins to
edge back up, having been stable at about 3.5% from
2018Q4 through 2019Q3. Fed tightening of this
magnitude may be necessary for the onset of
recession, but it may not be sufficient: the tipping
factor will probably be a significant deterioration in
financial conditions—most likely via the equity market.
The rest of this note walks through the evolution of
key economic variables through post-1960 cycles,
lining up where we are now with past performance.
Inflation accelerates more than real wages
Central banks—the Fed included—seem to be
adopting a view that any sign of inflation overheating
will be evident in the labor market, in the form of
rising wage inflation. It is hard to spot a consistent
acceleration pattern in real wages in the later stages
of business cycles, however (Chart 2). Note also that
the performance of real wage growth through this
expansion hardly stands out as weak (especially given
that productivity growth has been so anemic). Real
wage growth was weakest through the 1980s
expansion, mainly because inflation was higher.
Core CPI inflation does consistently accelerate late-
cycle (and into the recession), often in a “hockey stick”
fashion (Chart 3). Again, performance through the
current expansion does not look unusually weak
relative to past cycles (we seem to be tracking the
Clinton expansion of the 1990s). The experience of the
later 1960s is also worth bearing in mind,
Expectations began to rise from 1966 on and this
became a problem (there is a reason we cite
Friedman AER 1968). Note that this was also the only
0
2
4
6
8
10
12
0 12 24 36 48 60 72 84 96 108120
61 70
75 80
82 91
01 09
Chart 3
Core CPI
ex-food-and-energy; %oya
months of expansion
-7
-5
-3
-1
1
3
5
7
0 4 8 12 16 20 24 28 32 36 40
61Q1 70Q4
75Q1 80Q3
82Q4 91Q1
01Q4 09Q2
Chart 4
Corporate financing gap
Non-financial sector; % of gross value added
quarters of expansion
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
0 4 8 12 16 20 24 28 32 36 40
61Q1 70Q4
75Q1 80Q3
82Q4 91Q1
01Q4 09Q2
Chart 5
Business fixed investment
% point contribution to GDP; last 4q
quarters of expansion

3. Page 3
May 16th, 2018
other time that we have experienced a significant
peacetime fiscal expansion at full employment.
Business sector caution in context
While labor market signals point to late-cycle
conditions, this is less the case for measures of
corporate behavior. The creation of a significant
financing gap—the difference between cash flow
generated by operation and investment outlays—has
always been a reliable precursor of a downturn, and
we are currently some way from that (Chart 4). I would
expect this financial position to deteriorate over the
next few quarters. But even then, do not look for the
emergence of a gap similar to those seen in the past—
especially during the later 1990s. We will look back on
this expansion as one when the corporate sector—
scarred by near-death experiences in 2008-09—was
ultra-cautious. Business investment has been very
weak by historic standards (although is now picking
up; Chart 5). Manufacturing capacity utilization has
been running close to levels previously seen at the
end of recessions (Chart 6). The upside of this
excessive corporate caution is that the next recession
is likely to be quite mild (as in 1990-91 and 2001).
For all the talk of excessive debt creation through this
expansion, corporate lenders have been very
conservative and lending spreads have been
consistently higher than in previous ones (a mixture of
regulation and behavior). We are now close to the
lows in corporate spreads for this cycle but are poised
to move higher in coming quarters as the risks
associated with Fed tightening become more of a
focus (Chart 7).
Assessing the impact of tighter financial conditions
The main factors weakening demand growth through
2019 will be reduced fiscal thrust (fading demand
impact from tax cuts) and tighter financial conditions.
The personal sector saving rate is a channel through
which the latter operates although, once again, the
real move up tends to come through a recession
(Chart 8; check out the end point of each expansion
with the starting point of the subsequent expansion).
The stance of monetary policy is the main driver of
financial conditions. The level of the real Fed funds
rate has been the most extreme outlier condition of
this expansion to date (Chart 9). Negative real rates
were a standard feature of expansions in the 1970s.
The Volcker shock of 1980-81 opened the door to 20
years of significantly positive real rates. The past two
expansions have seen a return to sustained negative
real policy rates. With the exception of 1980, it is hard
to spot the Fed as murderer of the expansion. As the
expansion progresses, the Fed typically normalizes
rates, with the most significant increases coming in
waves from mid-cycle on (e.g. the long expansion of
the 1990s). This time around, normalization has been
60
65
70
75
80
85
90
95
0 12 24 36 48 60 72 84 96 108120
61 70
75 80
82 91
01 09
Chart 6
Capacity utilization
% of total
months of expansion
0
50
100
150
200
250
300
350
400
0 12 24 36 48 60 72 84 96 108120
61 70
75 80
82 91
01 09
Chart 7
Corporate debt spreads
bp; BAA over UST
months of expansion
0
2
4
6
8
10
12
14
16
0 12 24 36 48 60 72 84 96 108120
61 70
75 80
82 91
01 09
Chart 8
Personal sector saving rate
% disposable income
months of expansion

4. Page 4
May 16th, 2018
very delayed, with catch up now underway. This,
combined with extreme corporate caution, explains
why 325bp may be enough to create a recession.
The slope of the yield curve is widely accepted to have
useful cyclical properties. Two aspects stand out
about the recent experience, however. First, the curve
has been consistently steeper through this expansion
than in all other post-1960 expansions (Chart 10). This
has occurred despite QE. The unusual degree of curve
steepness is, of course, the consequence of such a low
Funds rate. Second, the most recent flattening fits
with a late-cycle pattern. The curve typically reaches
its flattest point about a year before the end of the
expansion. On my analog that would be sometime in
mid-2019.
Equity prices will have a powerful influence on the
saving rate. It is hard to spot a reliable pattern
between dips in prices and subsequent cyclical
developments, although real equity prices typically
level off in the last 2 years of an expansion (Chart 11).
Finally, oil prices have some very useful properties as
recession signals. Spikes preceded recessions in 1974,
1979, 1999-00 and 2007 (Chart 12). This is a key risk of
the President’s Iran policy.
Philip Suttle
phil@suttleeconomics.com
202-378-6793
Important Information
While we make every effort to ensure that the analysis in this
note is as accurate as possible, we do not guarantee that the
information contained is either complete or correct. The material
has been provided for informational and educational purposes
only. The information is not intended to provide or constitute
investment, accounting, tax or legal advice.
-5
-3
-1
1
3
5
7
9
0 12 24 36 48 60 72 84 96 108120
61 70
75 80
82 91
01 09
Chart 9
Real Fed funds rate
%; deflated by CPI
months of expansion
-150
-100
-50
0
50
100
150
200
250
300
0 12 24 36 48 60 72 84 96 108120
61 70
75 80
82 91
01 09
Chart 10
10s-2s UST slope
bp; 61 & 70 are 10s-1s slope
months of expansion
80
100
120
140
160
180
200
220
240
260
280
0 12 24 36 48 60 72 84 96 108120
61 70
75 80
82 91
01 09
Chart 11
Real equity prices
Trough = 100
months of expansion
0
50
100
150
200
250
300
350
400
450
25
50
75
100
125
150
175
200
225
250
0 12 24 36 48 60 72 84 96 108120
61
70
75
80
82
91
09
01 (RHS)
Chart 12
Real oil price
WTI deflated by US CPI; Trough = 100
months of expansion