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Economic Indicator Flashes Red. LEI Drops Further.
Is it just another recession prediction?
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The Reports of my Death are Greatly Exaggerated
Predictions of a US recession have been made for various time periods, ranging from early 2023 to mid-2023 to Q3 2023 to Q4 2023. However, none of these predictions have been correct. In fact, the US economy experienced a significant increase in Real GDP in Q3, with a growth rate of 4.9% on an annualized basis. Furthermore, the S&P 500 has surged by 17% since the start of the year, while the unemployment rate has consistently stayed below 4%. Inflation, which was high last year, has dropped to around 3%, close to the Federal Reserve's target of 2%.
However, the latest inflation data has led to a drop in bond yields as traders anticipate future rate cuts by the Federal Reserve. The 10-year yield, which had been a concern for stocks as the Fed indicated higher rates for a longer period, has decreased to around 4.4% from its peak of 5% in October. This decrease in bond yields could be an indication of an impending recession as lower yields often signal an expectation of lower inflation and slower economic growth.
Economic Indicator Flashes Red
Another leading economic indicator is flashing red, the Conference Board's Leading Economic Index (LEI). The LEI fell 0.8% to 103.9 in October after falling 0.7% in September, marking 19 months of consecutive decline. This negative trajectory of the LEI, along with its six- and twelve-month growth rates holding in negative territory, signals a potential recession in the near term.
The last time the index fell for so many consecutive months was during the Great Recession of 2007-2009. Despite this, some argue that the U.S. economy isn't nearing a recession because the NBER hasn't announced one yet. However, NBER often announces a recession long after it has started, and sometimes even after it has ended.
The LEI is a predictive variable that anticipates turning points in the business cycle by around seven months. The LEI is composed of 10 components, including average weekly hours in manufacturing, average weekly initial claims for unemployment insurance, manufacturers' new orders for consumer goods and materials, ISM Index of New Orders, manufacturers' new orders for nondefense capital goods excluding aircraft orders, building permits for new private housing units, S&P 500 Prices, Leading Credit Index, interest rate spread (10-year Treasury bonds less federal funds rate), and average consumer expectations for business conditions. It is intended to signal swings in the business cycle.
The LEI has been a reliable indicator for predicting business-cycle recessions. It accurately predicted the 2001 recession and the Great Recession. However, it did not predict the pandemic recession as it was not a typical business-cycle recession but rather a result of the pandemic and subsequent lockdown measures. Instead of predicting it, the LEI reacted simultaneously with the recession, which is the appropriate response. Looking ahead, the Conference Board forecasts that real GDP will only expand by 0.8 percent for the entire year of 2024. This indicates a significant slowdown in economic growth compared to previous years.
**Please take note that this significant economic indicator has received surprisingly little media attention. Typically, discussions surrounding this indicator tend to surface only after a recession is officially declared, when our focus should be preemptively directed towards it.**
Coincident and Lagging Economic Indexes
There are two other indexes the Conference Board releases as well. They are the Coincident Economic Index (CEI) and the Lagging Economic Index (LAG). The CEI for the U.S. remained unchanged in October 2023 at 110.8 (2016=100). However, it is below its September level after a downward revision. The LAG for the U.S. improved by 0.1% in October 2023 to 118.6 (2016 = 100), following the same rate of increase as in September. Over the six-month period from April to October 2023, it increased slightly by 0.3%, down three-fold from its 0.9% growth over the previous six months.
The CEI is a measure of current economic activity and helps identify the current state of the economy. It includes four components: payroll employment, personal income less transfer payments, manufacturing and trade sales, and industrial production. These indicators are used to determine recessions in the US. The LAG is a measure that lags behind the overall economy; it includes indicators that change after the overall economy does.
There seems to be a relationship between the LEI and CEI as a leading indicator as well. Like the LEI, the LEI/CEI ratio has been in decline for the past 19 months. There are instances when the ratio has been in decline for several months without a recession.
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