I must ad­mit that I’m con­fused

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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.

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