San Francisco Fed says Europe may pull US back into recession

Researchers from the Federal Reserve Banks of San Francisco and Kansas City say the odds of a U.S. recession in 2012 are greater than 50% because of the European debt crisis. The figure below shows the recession-probability forecasts. The lines represent complex Leading Economic Index-based predictions the researchers previously made. “To interpret these predictions, think about an experiment in which two coins are flipped, with heads representing recession and tails expansion,” the researchers say in an economic report. “One coin represents the recession odds from domestic factors, the other coin from international factors. The figure below shows the probabilities of flipping heads with the domestic and international coins. The overall probability of recession is reflected in the thick blue line.” The combination of the two recession coins, shown in the combined risks line, indicates the odds are greater than 50% that we will experience a recession sometime early in 2012, the Fed researchers say. Back in September, fund managers surveyed by Bank of America Merrill Lynch (BAC) said they believe Europe will slide into a recession in the coming months. Roughly 68% of survey respondents viewed the euro zone debt crisis among the largest of risks to global investments. In the next few months, the odds of a U.S. recession due to domestic factors appear reasonably contained, the researchers say. Those odds increase gradually and reach about 30% in the second half of 2012, after which, they decline. Recession odds based on international factors peak at about 45% toward the end of 2011, but decline rapidly thereafter. “The message is clear. Prudence suggests that the fragile state of the U.S. economy would not easily withstand turbulence coming across the Atlantic,” the report states. “A European sovereign debt default may well sink the United States back into recession. However, if we navigate the storm through the second half of 2012, it appears that danger will recede rapidly in 2013,” they conclude. Write to Justin T. Hilley. Follow him on Twitter @JustinHilley.

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