by Calculated Risk on 10/04/2011 12:26:00 PM

The following article makes a few key points that we've been discussing:
• It is very unlikely that the U.S. economy was in a technical recession at the end of Q3. In fact, Goldman revised up their Q3 forecast to 2.5% (Merrill Lynch and others revised up their Q3 forecasts too). The recent data suggests sluggish growth, not recession (examples include the ISM manufacturing survey showing expansion in September, the Chicago PMI increasing, and auto sales back up over 13 million SAAR).

• There are clear downside risks to the U.S. economy mostly from the European financial crisis, the apparent renewed recession in Europe, and from U.S. fiscal tightening. However the potential spillover from Europe is difficult to quantify.

• Since the cyclical sectors in the U.S. remain very depressed, it is difficult for those sectors to fall significantly. Usually these sectors decline prior to a recession in the U.S., and that is not happening now.

From Jeff Cox at CNBC: Recession Chance 40% in 2012, Jobless Rate to 9.5%: Goldman

Jan Hatzius, Goldman's chief US economist, pegged recession chances at 40 percent and said the jobless rate is likely to surge to the mid-9 percent range in 2012.

While that still jibes with the firm's forecast that a recession — or two consecutive quarters of negative growth — is not the most likely scenario, the warning signs flashed Tuesday underscore concerns about European debt contagion on an already fragile US economy.

Here are the upside and downside risks from the research note:

The upside risk is that either financial stresses ease--with the most likely cause of this a more aggressive and coordinated move by European policymakers to turn the tide--or that the spillovers from those financial stresses into US credit and financial conditions prove relatively limited. The quickest and easiest way to gauge the former is the behavior of borrowing spreads for sovereigns in the European periphery, and banks in the Eurozone as a whole. ... Without a clear pass-through into domestic financial or credit conditions, the base-case outlook would revert to our previous forecast of trend or slightly-below trend growth in 2012. (The "hard data" on the economy have held up sufficiently well in the third quarter that we now expect 2.5% growth in Q3, from 2.0% previously.)

The downside risk is of course that these financial spillovers--or conceivably some other shock, perhaps greater fiscal tightening in 2012 than we now anticipate--prove sufficient to push the US economy into recession; both a quantitative model and our subjective assessment put recession risk in the neighborhood of 40% at this point. For now, we still think the base case is that the US economy avoids this outcome. The cyclical sectors of the economy are already quite depressed--in particular, homebuilding is barely above the depreciation rate of housing--so downside looks more limited.