Cycle s turn ng

S mon McAdam, econom st, Cap tal Econom cs

Many of the financial and economic indicators that turn first around business cycle peaks are now flashing red in advanced economies. This is consistent with our view that the recent loss of momentum in the world economy will develop into a more severe slowdown in 2019. The bond market and investment growth are usually first to turn, often a year or more before the peak in the cycle. Second, falling equity prices and consumer confidence typically occur within the year prior to the cycle peak. Third, the labour market turns later, followed by declines in the real stock of private credit and core inflation – all of which are generally lagging indicators. Admittedly, there are no cast-iron laws determining the sequence of events leading up to downturns – there has been a lot of variation in when the indicators have turned. And the signs don’t always flash red before downturns: in eight cases, all outside the US, yield curves hadn’t flattened significantly, and in ten cases the unemployment rate did not rise. What’s more, there have been plenty of occasions when the indicators have turned, but no downturn followed. But the point is that if several indicators flash red in tandem, there is stronger evidence of a turn in the cycle. So how do the G7 economies currently shape up? What jumps out is just how many of the leading indicators are flashing red, especially in the US, UK and Canada, where growth is currently holding up well. By contrast, the German economy has lost momentum recently but, for now at least, few of the indicators point to a marked slowdown next year. In most G7 economies, a downturn does not appear to be imminent. For one thing, yield curves have not steepened, which is what tends to happen in the months immediately running up to the cycle peak as bond investors begin pricing in rate cuts. Moreover, in general, non-residential investment and industrial production are not yet contracting.

(December 21)