US Business Cycle Risk Report | 23 November 2018

Recession risk for the US remains low at the moment, but the signs are piling up that economic growth is slowing. The nine-year-old expansion will remain intact through the end of the year and persist into the early months of 2019, but next year’s second quarter-plus looks wobbly.

As The Capital Spectator has been pointing out for several months, the data is telling us that growth has peaked (see here and here, for instance). Deciding what this means going forward, however, is still open for debate.

Let’s remember that looking ahead beyond two to three months at most is highly speculative and so a high degree of caution is required for making assumptions beyond January. Meantime, the numbers in hand strongly suggest that we’ll see a softer round of growth for the final quarter of 2018. The rate of increase through the end of this year into the first month or so of 2019 is set to remain strong enough to keep recession risk low. The question is whether the downshift underway will continue? It’s too early to answer with any confidence at this point, but it’s also premature to rule out the possibility of increasingly softer growth, perhaps bordering on stagnation (or worse) at some point in the new year.

In any case, close monitoring of the incoming data is a high priority in the search of early, high-confidence signals for evaluating recession risk.


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Meanwhile, reviewing a broad set of indicators today continues to estimate a virtually nil probability that a new NBER-defined downturn started in October, according to analysis of a diversified set of economic indicators. (For a more comprehensive review of the macro trend with weekly updates, see The US Business Cycle Risk Report.) Based on this data, Monday’s October update of the Chicago Fed’s National Activity Index (via the three-month average) will likely confirm that recession risk remained low last month.

Aggregating the data in the table above continues to indicate a positive trend overall through last month, albeit a trend that’s been decelerating through most of this year. Despite the slide, the Economic Trend and Momentum indices (ETI and EMI, respectively) remain well above their respective danger zones (50% for ETI and 0% for EMI). When/if the indexes fall below those tipping points, the declines will mark warning signs that recession risk is elevated and a new downturn has started or is near. The analysis is based on a methodology that’s profiled in my book on monitoring the business cycle.

Although ETI and EMI remain in positive terrain,  both indexes have been falling in 2018, as shown in the chart below. The deceleration may run its course at some point and stabilize, and so its premature to read too much into the downside bias at this point. As the historical record for these indexes reminds, periods of deceleration can sometimes be temporary affairs that eventually lead to rebounds rather than recessions.

Translating ETI’s historical values into recession-risk probabilities via a probit model points to low business-cycle risk for the US through last monthAnalyzing the data in this framework indicates that the odds remain effectively zero that NBER will declare October as the start of a new recession.

For the near-term outlook, consider how ETI may evolve as new data is published. One way to project values for this index is with an econometric technique known as an autoregressive integrated moving average (ARIMA) model, based on calculations via the “forecast” package in R. The ARIMA model calculates the missing data points for each indicator for each month — in this case through December 2018. (Note that August 2018 is currently the latest month with a complete set of published data for ETI.) Based on today’s projections, ETI is expected to remain above its danger zone through next month. Nonetheless, the ongoing slide in ETI is worrisome and so the possibility exists that the index will fall through the critical 50% mark at some point in 2019, which would indicate the start of a new NBER-defined recession.

Forecasts are always suspect, but recent projections of ETI for the near-term future have proven to be reliable guesstimates vs. the full set of published numbers that followed. That’s not surprising, given ETI’s design to capture the broad trend based on multiple indicators. Predicting individual components, by contrast, is subject to greater uncertainty. The assumption here is that while any one forecast for a given indicator will likely be wrong, the errors may cancel out to some degree by aggregating a broad set of predictions. That’s a reasonable view, based on the generally accurate historical record for the ETI forecasts in recent years.

The current projections (the four black dots in the chart above) suggest that the economy will continue to expand for immediate future. The chart also shows the range of vintage ETI projections published on these pages in previous months (blue bars), which you can compare with the actual data (red dots) that followed, based on current numbers.

For more perspective on the track record of the ETI forecasts, here are the vintage projections in the past three months:

19 October 2018
20 September 2018
17 August 2018

Note: ETI is a diffusion index (i.e., an index that tracks the proportion of components with positive values) for the 14 leading/coincident indicators listed in the table above. ETI values reflect the 3-month average of the transformation rules defined in the table. EMI measures the same set of indicators/transformation rules based on the 3-month average of the median monthly percentage change for the 14 indicators. For purposes of filling in the missing data points in recent history and projecting ETI and EMI values, the missing data points are estimated with an ARIMA model.

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