US Business Cycle Risk Report | 21 February 2019

The US economic trend continues to slow, but the deceleration – so far – has been gradual and non-threatening in terms of raising recession risk to a critical level. In other words, moderate growth prevails, albeit with a downside bias. If the deceleration rolls on, the potential for trouble may become elevated in the second half of 2019.

The critical question in the months ahead boils down to: Is the economy suffering from a soft patch that will stabilize or give way to reacceleration or are we in the early stages of an approaching recession? At this point it’s too early to know which scenario will unfold. Meantime, the case is weak for arguing that a downturn will begin in this year’s first quarter.

What is clear is that growth peaked in mid-2018 and the slowdown is ongoing. Next week’s delayed 2018 fourth-quarter report on gross domestic product (GDP) is expected to reaffirm this analysis. The Wall Street Journal’s February survey of economists indicates that Q4 growth is on track for a 2.5% gain — down from Q3’s 3.4% and Q2’s 4.2%.

The slowdown looks set to continue in this year’s first quarter, according to the current nowcast from The firm’s Feb. 15 estimate is a sluggish 1.8% for Q1 GDP growth — the softest quarterly pace in two years.

To be fair, it’s still early for developing confidence about Q1, but The Capital Spectator’s revised trend analysis restates a theme that’s been consistent on these pages for months (see here, for instance): economic activity is easing. The good news: there’s a low probability that a new NBER-defined downturn started in January, according to analysis of a diversified set of economic indicators shown in the table below. (For a more comprehensive review of the macro trend with weekly updates, see The US Business Cycle Risk Report.) Today’s macro profile — no recession as of January — will likely be confirmed in next week’s January update (due on Monday, Feb. 25) of the Chicago Fed’s National Activity Index (via the three-month average).

Aggregating the data in the table above continues to indicate a growth trend overall through last month, although the strength of the expansion continued to ease, albeit fractionally so. The Economic Trend and Momentum indices (ETI and EMI, respectively) dipped in January from December and are now reflecting the slowest growth since the late-2015/early 2016 soft patch. Note, however, that both business-cycle benchmarks remain moderately 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 outlined in my book on monitoring the business cycle.

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 roughly 1% that NBER will declare January 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 March 2019. (Note that November 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. Keep in mind, however, that the ongoing slide in ETI warrants close monitoring because the possibility exists that the index will fall through the critical 50% mark at some point in 2019 — a slide that 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 in the 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:

18 January 2019
21 December 2018
23 November 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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