US Business Cycle Risk Report | 19 November 2015

Confidence in the US economy has wobbled over the last several months, in part due to mixed updates for several key indicators. But drawing conclusions about the broad trend by cherry picking data points is a dangerous game if you’re looking for reliable estimates of recession risk. Recent history reaffirms this message quite clearly. Despite the rush in some corners this autumn to declare that a new downturn is fate, a diversified set of economic and financial indicators has yet to confirm such claims.

But pessimism springs eternal, and eventually the dark forecasts will be right. Blackstone Group President Tony James, for instance, said that a US recession is a possibility for 2017. Not next year, but the year after, he warned. “It wouldn’t surprise me if we had one in 2017,” he advised at a conference yesterday. “I’m turning more pessimistic now. There are a lot of headwinds facing us right now.”

Perhaps, but for the moment the odds are low that a new recession has already started, based on the published numbers to date. Near-term projections through the end of the year also point to a positive macro trend.

The relatively upbeat analysis at present is based on a methodology outlined in Nowcasting The Business Cycle: A Practical Guide For Spotting Business Cycle Peaks. Using this framework, an aggregate of economic and financial trend behavior shows that business-cycle risk remained low through last month, based on the Economic Trend and Momentum indices (ETI and EMI, respectively). The current profile of published indicators through last month  (12 of 14 data sets) for ETI and EMI continue to signal a positive trend overall. The lone exception in October: the corporate bond spread. Otherwise, positive trending behavior dominates.

Here’s a summary of recent activity for the components in ETI and EMI and the various calculations that are used to calculate the trend benchmarks:


Aggregating the data into business cycle indexes reflects positive trends overall. The latest numbers for ETI and EMI indicate that both benchmarks are well above their respective danger zones: 50% for ETI and 0% for EMI. When the indexes fall below those tipping points, we’ll have clear warning signs that recession risk is elevated. Based on the latest updates for October — ETI is 85.7% and EMI is 3.3% — there’s still a wide margin of safety between current values and the danger zones, as shown in the chart below. (See note at the end of this post for ETI/EMI design rules.)


Translating ETI’s historical values into recession-risk probabilities via a probit model also points to low business cycle risk for the US. Analyzing the data with this methodology implies that the odds are virtually nil that the National Bureau of Economic Research (NBER) — the official arbiter of US business cycle dates— will declare last month as the start of a new recession.


For another perspective, consider how ETI may evolve as new data is published.  One way to project future 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 for R, a statistical software environment. The ARIMA model calculates the missing data points for each indicator, for each month–in this case through Dec. 2015. (Note that Aug. 2015 is currently the latest month with a complete set of published data.) Based on today’s projections, ETI is expected to remain well above its danger zone for the near term. (Keep in mind that frequent business cycle updates are available throughout each month with The US Business Cycle Risk Report.)


Forecasts are always suspect, of course, but recent projections of ETI for the near-term future have proven to be relatively reliable guesstimates vs. the full set of published numbers that followed. That’s not surprising, given the broadly diversified nature of ETI. Predicting individual components, by contrast, is prone to far more uncertainty in the short run. The current projections (the four black dots on the right in the chart above) suggest that the economy will continue to expand. The chart above also includes the range of vintage ETI projections published on these pages in previous months (blue bars), which you can compare with the actual data that followed, based on current numbers (red dots). The assumption here is that while any one forecast for a given indicator will likely miss the mark, the errors may cancel out to some degree by aggregating a broad set of predictions. That’s a reasonable assumption via the historical record for the ETI forecasts.

For additional perspective on judging the track record of the forecasts, here are the previous updates for the last three months:

21 Oct 2015
18 Sep 2015
19 Aug 2015

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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