Table of Contents
2. Globicus Leading Indexes Improves. 2
3. Yield Curve Still Negative. 5
5. Why a False Signal of Recession?. 8
6. The US Economy Is Still Expanding. 11
1. Executive Summary
Globicus’ Leading Economic Indexes (LEI) were mostly positive in the latest reading and have improved significantly this year. This indicates the US economy is likely to continue its expansion during the second half of 2024. The long leading index (LLI) is still negative, and the yield curve (usually a reliable indicator) is still inverted. Globicus will closely follow the further development in the indexes.
As for the present situation the Sahm’s rule and National Bureau of Economic Research’s (NBER)[1], Business Cycle Dating Committee’s recession indicators both indicate the US economy is not currently in a recession. The extraordinarily large monetary and fiscal stimulus programs may have avoided a recession and given a false signal of a recession via the LEI in 2023.
2. Globicus Leading Indexes Improves
Globicus Leading Economic Indexes (Total- Long- and Short leading index)[2] were mixed in the latest reading for May/April, still indicating further expansion for the US economy and low risk of a recession in the near term.
New and revised data showed the total leading index (TLI) rose to 0.1 Six-Month Smoothed Growth Rate (“SMGR”)[3] in May from 0 in April, the fourth consecutive non-negative growth rate. The long leading index (LLI) dropped to -3.7 in April from -3.1 in March but is well above its -7.3 low of October 2022. The short leading index (SLI) remained at 3.0 in May, the same as in April and its twelfth positive monthly reading. Overall, the leading indexes indicate a reduced risk of a recession and continuation of the current economic expansion. The long leading index is still negative but, in an uptrend (rising). Usually, this index declines from a positive level for years, before a recession develops. When the trend in the LLI has been rising from a negative level as now, the only time a recession has occurred was at the double recession in the early eighties when Paul Volker was the Fed Chairman. At that time the Fed funds rate basically doubled from the end of the 1980 recession, from about 9% in July to about 20% in December 1980. The LLI rose from a low of -16.3 in April 1980 to a peak of 1.4 in November 1980, then it declined to -9.2 in July 1981 when the new recession started. Therefore, as the LII Is rising today, the historical record makes it unlikely that we will see a recession soon or even this year.
The coincident Index (designed to coincide or measure overall economy growth in the US economy) is moderating, following strong growth at the end of last year. The index was 0.9 in April 2024 following 1.1 SMGR the previous month, so growth is slowing but still respectable.
3. Yield Curve Still Negative
One of the most reliable indicators in the long leading index, the 10-year/3-month yield spread, turned negative last year. Historically when that happened a recession always followed, except after the inverted yield-curve in 1967. Today the inversion is still significantly negative (-1.24 on June 17) and could pose a challenge to our interpretation of a continued expansion of the economy.
The 3-month rate is highly correlated with the fed funds rate, and the Fed may lower rates if inflation continues to decline. In the Fed’s latest Summary of Economic Projections[4] the FOMC push the easing further out in the future, but it did not change the number of rate cuts and therefore the future curve stayed much the same. The median Fed member predicted one 25 basis point cut in 2024 and four cuts in 2025. A decline in the inflation rate may let the Fed to lower the fed funds rate according to its plan. Therefore, a gradual decline in the fed funds rate may lead to a normalization in this spread for the second time since 1967 without a recession. However, if the unemployment rate increases more than Fed’s expectation of 4% this year and 4.2% next year. The risk of a recession will significantly increase and there may be much faster rate cuts. As we show in a simulation below.
4. No Recession
The Sahm Rule[5] identifies signals related to the start of a recession. When the three-month moving average of the unemployment rate rises by 0.5% or more from its 3-month moving average of the previous 12 months lows, the economy has been in a recession. This is not a leading indicator but coincides with recessions and as you can see it indicates no recession as unemployment has not risen enough yet. The index was at 0.37 in the last two readings for April and May. This indicator also corroborates the coincident index and the NBER recession indicators which also show the US economy still expanding.
We have simulated Sahm’s recession rule by assuming that the unemployment rate rises 0.1% in June and July from 4.0% in May and then stays at 4.2% until September. This would mean the US economy would start a recession in September according to the rule. The red line is the trigger level for a recession and the blue line is the simulated unemployment indicator. When the three-month moving average of the unemployment rate rises by 0.50% or more, relative to the minimum of the three-month moving averages from the previous 12 months, the US economy is in recession according to the rule. The simulation shows that not much of a deterioration in the labor market can cause a recession according to the rule.
5. Why a False Signal of Recession?
Below are the model’s results since 1970. The blue line is the model’s total leading growth rate, designed to forecast economic activity and recessions. The red line is the coincident index, designed to measure current economic activity. This model has been reliable in the past. When the total leading index turns negative it precedes a recession by on average, but not always, by 9 months. These leads vary greatly but have never been this long. The total index turned negative in the beginning of 2022 and reach a bottom in October the same year. Usually this happens in the beginning or middle of the recession. Therefore, we conclude it was a false recession signal and the recession may have been canceled by the extraordinary stimulative monetary and fiscal policy during and after the Covid pandemic.
The US has had an extraordinarily lax monetary policy. Additionally, the Fed was very late in beginning its tightening cycle. The first increase in the fed funds rate was in March 2022, the same month inflation reached 8.5%. Furthermore, the unprecedented fiscal policy expansion, even though unemployment was exceptionally low, has contributed to the strong economic growth. Both policies have no doubt contributed to the strong US economic performance but also to inflation. The policies may have helped the economy in the short run but they are not necessarily beneficial to the long run health of the economy.
Moreover, the US government’s interest payments have nearly doubled since 2020. This is the result of both higher government spending and higher interest rates. We normally think higher interest rates reduce spending. Higher interest payments are income for lenders and expenses for borrowers. In the private sector, higher rates reduce demand, and it is the Fed’s main policy tool for inflation control. However, when it comes to government interest payments it is a net positive for the private sector as it leads to higher income for holders of government debt and is a government stimulus for the economy. The government interest payments were $1,059 billion in the first quarter 2024, about the same as defense spending, and 3.74% of nominal GDP up from 2.4% in 2020.
Despite the Fed’s late but relatively aggressive rate hike campaign, it seems like they did not overtighten, at least not yet. One measure of the Fed’s monetary policy stance is annualized nominal GDP growth relative to the fed funds rate. The chart below shows that this spread only got marginally negative in this cycle. In previous recession episodes, the spread between GDP growth rate and fed funds rate turned significantly negative, leading to recessions. Nominal GDP appears to be slowing, while no fed fund rate cut seems to be immediate, so this indicator should be watch for signs of overtightening.
6. The US Economy Is Still Expanding
NBER’s Business Cycle Dating Committee keeps a chronology of the US business cycles. The committee’s definition of a recession is “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”[6]
The committee’s determination of the months of peaks and troughs is based on a range of monthly measures of aggregate real economic activity. These include real personal income less transfers, nonfarm payroll employment, employment as measured by the household survey, real personal consumption expenditures, wholesale-retail sales adjusted for price changes, and industrial production. It is clear from the chart below that there is currently no significant decline in economic activity shown in these indicators.
In addition to the monthly indicators, the Dating Committee uses two quarterly indicators, gross domestic product (GDP) and gross domestic income (GDI). GDP rose 1.3% in the first quarter (2.9% y/y), following 3.4% in the fourth quarter and GDI rose 1.5% in the first quarter (1.9% y/y) following 3.6% in the previous quarter.
The monthly indicators the Dating Committee uses to date the start and end of a recession mostly expanded according to the latest available data. The only indicators that show some moderating are industrial production and the employment level but no significant downturn. The Dating Committee will not call a recession on these numbers. The criterion for a recession is that the economic weakness is widespread and has lasted more than a few months.
7. Conclusions
The latest reading of Globicus’ leading indexes indicates that the US economic expansion is likely to continue. The total leading index indicates that the US economy expansion will continue in the second half of 2024. The short leading index was strong and has been positive since June 2023. The long leading index is still negative, but it has risen from -7.7 in October 2022 to -3.7 in the latest reading of April 2024. Therefore, the probability of an impending recession is low.
The leading indexes have earlier shown an elevated risk of a recession, but the last few quarters’ development signal that the risk of a recession has declined, and we do not expect a recession in the second part of 2024.
From Globicus’ coincident index, the Sahm’s rule and NBER’s Dating Committee’s data used to track recessions the US is not in a recession now.
[1] National Bureau of Economic Research is a private, nonpartisan economic research organization. The NBER’s Business Cycle Dating Committee maintains a chronology of US business cycles as well as decides the dates of the recessions.
[2] We are using three leading indexes. The reason for this is that leading indicators have different lead time, and it can be useful to disaggregate what the long and short leading indexes indicates. The total leading index is a combination of the short and the long leading index and is constructed to smooth out the volatility of the individual indexes and to get a timely indication.
[3] For input series X the formula for six-month smoothed growth rate is: Xsmgr= (X(t)/Avg of previous 12 months)^(12/6.5)-1
[4] https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20240612.pdf
[5] Sahm, Claudia, Sahm Rule Recession Indicator [SAHMCURRENT], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/SAHMCURRENT
[6] NBER Business Cycle Dating; https://www.nber.org/research/business-cycle-dating