US Business Cycle Risk Report | 24 July 2018

Trade tensions and geopolitical risk remain potential threats to US economic growth in the second half of the year and beyond, but the search for smoking guns in the published numbers continues to turn up empty. Near-term estimates of the US business cycle point to a mild deceleration in the trend (see details below). It’s unclear at this stage if the projected softening is a warning sign or noise. What’s beyond doubt is that the indicators published to date reflect a solid run of growth.

Yesterday’s update of the Chicago Fed National Activity Index for June confirms that the US economy ended the second quarter on a healthy note. The benchmark’s three-month average ticked up to 0.16 last month. Although that’s well below the recent peaks, the current reading is far above the -0.70 mark that signals the start of recessions.

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Economists are increasingly worried that the escalating trade tensions between the US vs. China and Europe could bring trouble in the months ahead. But it’s far from clear at this stage that a substantial setback for the US is fate. In fact, by some accounts, trade-war rhetoric and recent decisions by the US to impose tariffs on imports may have temporarily lifted output.

The “threat of a trade war appears to have bolstered activity in the second quarter,” observes senior economist Eric Winograd at AllianceBernstein. Economists Michelle Girard and Kevin Cummins of NatWest Markets agree, writing in a research note that “efforts to front-load shipments prior to US tariffs being instituted on July 6 may have bolstered exports of other goods as well.”

The macro sugar rush may fade later in the year, but for now the expansion is in high gear. The government’s “advance” estimate of US second-quarter GDP that’s due on Friday (July 27) is expected to reflect a surge of growth: 4.2%, based on’s consensus forecast. If correct, the economy expanded at more than double Q1’s subdued 2.0% pace.

Unsurprisingly, The Captial Spectator continues to estimate a virtually nil probability that a new NBER-defined downturn started in June, based on 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.)

Aggregating the data in the table above continues to reflect a strong positive trend overall. 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 overt warning signs that recession risk is elevated and a new downturn is imminent. The analysis is based on a methodology that’s profiled in my book on monitoring the business cycle.

Translating ETI’s historical values into recession-risk probabilities via a probit model also 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 June 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 August 2018. (Note that April 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 well above its danger zone through next month.

Note, however, that today’s projected ETI estimate for August is 79% — the first dip below 80% for the index in more than a year. It’s premature to read too much into this decline. Nonetheless, the numbers are telling us that the cycle may have peaked.

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. 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:

22 June 2018
18 May 2018
20 April 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.