By Shrutee Sarkar
BENGALURU (Reuters) - The risk of a U.S. recession in the next two years has risen to 40 percent, according to a Reuters poll of economists who also found a significant shift in expectations toward fewer Federal Reserve interest rate rises next year.
What has fueled concerns of a downturn is the flattening of the U.S. yield curve - with the spread between two- and 10-year note yields falling to less than 10 basis points, the smallest gap since the run-up to the last U.S. recession.
A flattening yield curve suggests investors believe economic growth and inflation will slow. A yield curve inversion has preceded almost all recessions over the last half-century.
The probability of a U.S. recession in the next two years has jumped to 40 percent, according to the median of those polled, the highest since that question was first asked in May this year.
Before that, the last time such a high probability appeared in a Reuters poll was in January 2008, just eight months before the collapse of U.S. investment bank Lehman Brothers, which brought on the Great Recession.
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The range of forecasts, which runs from 15 to 75 percent, also points to a higher probability of a recession in the next two years compared to a poll conducted just last month, which had a median 35 percent chance.
Those conclusions line up with recent Reuters polls of a total of over 500 economists, fund managers, currency analysts and equity strategists which have clearly showed economic momentum in the United States has peaked and a downturn may be approaching soon.
The U.S. Treasury yield curve was forecast to invert next year, and possibly in the next six months, with a recession expected to follow as soon as a year after that, according to a separate Reuters poll of fixed-income strategists on Thursday. (Reuters poll graphic on U.S. 2-10 year Treasury yield spread: https://tmsnrt.rs/2PBzevy)
"The combination of a Fed that does not think that inverting the yield curve is a problem (along with) a global outlook that is not likely to improve in a sustained manner, is likely to lead to a monetary policy error that will push the economy into recession," noted Philip Marey, senior U.S. strategist at Rabobank. "How many hikes this may take is still unclear."
The latest poll of over 100 economists taken Dec 6-13 showed the U.S. economy will slow in the coming quarters with annualized gross domestic product growth easing to 1.8 percent by mid-2020, about half the latest reported rate of 3.5 percent.
"I think all of the impetus for growth will fade in 2019. So where is the growth going to come from?" asked Joel Naroff, chief economist at Naroff Economic Advisors.
"Are we definitely going into a recession? I can't say that," said Naroff. But, he added, "I haven't had negative (GDP) numbers on my forecast for nine years now, and 2020 is the first time I have put negative numbers into the forecast."
The survey follows a rough period for global stock markets which has knocked the Standard & Poor's 500 index down to an eight-month low this week and showed a decisive shift in expectations for the Fed's rate hike path over the next year.
While economists in the latest poll unanimously said the central bank will raise rates on Dec. 19, the consensus points to just two increases in 2019, taking the fed funds rate to 2.75-3.00 percent by the end of next year.
That is one rate hike less than the three increases predicted in the previous poll and by the Fed in its most recent economic projections released in September. The Fed will update its forecasts at its Dec. 18-19 meeting.
But fed funds futures are pricing in only one more rate rise next year. Indeed, 37 of 58 economists, over 60 percent, who responded to an extra question said their conviction has shifted toward fewer increases compared to a month ago.
"If Fed tightening is an important factor escalating recession risks in 2019, then a pause in tightening should be sufficient to prevent those risks from materializing," noted economists at Morgan Stanley.
Fed officials have only just recently begun flagging a "turning point" for policy.
The poll also forecast the Fed's preferred inflation gauge, core PCE prices, would average 2.0 percent in 2019 and then 2.1 percent in 2020.
(Additional reporting and analysis by Sujith Pai and Manjul Paul; Graphics and polling by Vivek Mishra; Editing by Ross Finley and Andrea Ricci)