I must admit that I’m confused
Friday saw the release of US jobs market data for August which had investors convinced of a continued “not too hot, not too cold” outlook for the world’s largest economy. This is at odds with the view that I have held for a while; namely, that the US has been on the brink of recession or may have even entered one. This prognosis was based on a hopefully not insubstantial analytical foundation, which may be worth reviewing. Let’s start with economic activity: 1) Private sector GDP: The 12-month rate of change stands at 1.3% YoY, a level which since 1968 has always coincided with a recession.
2) Industrial production: The six-month moving average of the 12-month rate of change has been negative for a good while, which since the 1930s has never occurred outside of recession conditions.
3) Non-financial profits (national accounts): Since the 1950s these have not been lower than three years ago without a recession (save 1986-87).
4) Capital spending: The two-year rate of change is negative and (save for 1987) this situation has always coincided with a recession.
5) New home building permits: The 12-month change has swung negative, which has often recession signal.
6) Exports: The six-month moving average of the 12month rate of change has gone negative, which has almost always coincided with a recession (there have been recessions with export growth).
7) Industrial sales: The YoY change is in negative territory, which has usually been associated with a recession.
8) Tax receipts: The six-month moving average of two year variations is negative, which has never happened outside of a recession.
9) Employment: Variations on a 12-month basis remain positive, but are decelerating. Tends to lag economic growth by about a quarter.
10) Consumer spending: Real retail sales generating about 1% growth, yet consumer spending above 2% YoY (Obamacare impact?).
Also consider the data.
1) US real monetary base: The 12-month variation is negative, which has always coincided with a recession (there have also been quite a few recessions when real base money was rising on a YoY basis).
2) Corporate spreads: There has been a massive narrowing since February with Baa and junk bonds yields falling faster than economic activity.
A little more than a year ago, I built a recession indicator for the US economy which included most of the factors mentioned above. The recession frontier of this tool stands at —5 and in the intervening period the reading has varied from 0 to -9. It is now recording -3.
In order to better understand the reasons for this recovery, I have broken the recession indicator into two parts, with the first part being based on the official data, and the second being derived from market-based measures such as corporate spreads, commodity prices and equity indexes.
(non-output rate been
related) of a
base The former “hard” data makes up about two thirds of the indicator and the latter, “market” or “forward-looking”, part constitutes about one third. It is in this market part where all the improvement has been registered, with the reading rising from a low of -4 early in the year to +2. By contrast, the hard data piece of the indicator has maintained a steady deterioration, with the subset reading going from –3 to –5. The one similar, although not as pronounced, situation was in 1999.
So how to explain this seeming dissonance? On the one hand, US financial markets have since February been heralding an improvement in the US economy, which six months on, is nowhere to be seen. Or perhaps the markets simply operated on the basis that the Federal Reserve would do whatever it took to avoid a recession in a presidential election year. Or perhaps central banks really did coordinate after the Shanghai meeting of G20 finance ministers in February as part of a concerted global price keeping operation. Whatever the reasons behind the pick-up, it seems clear that the US economy must now start to recover, or alternatively the market-based components of my indicators could soon roll over.
It seems clear that the non-services part of the US economy is in a recession and has been for a good while. Moreover, I cannot remember a time when the Fed would have considered raising rates while the industrial economy faced such a situation. As such, raising interest rates at this juncture would constitute a significant policy mistake (which is precisely why it is quite likely to happen). To understand why this outcome is likely, it is only necessary to note that not raising rates would constitute an admission that the policy settings of the past five years have failed. Sadly, I cannot find a neat conclusion to this very messy and muddled tale.