Authored by Steven Hansen

EconCurrent‘s Economic Index marginally improved over a downwardly revised September forecast and continues in negative territory. Inflation overall remains unchanged compared to last month – a strange situation after the Federal Reserve declared progress on curtailing inflation. Currently, we do not forecast a recession in the near term. Read on to understand the currents affecting our economic growth.

Analyst Summary of this Economic Forecast

The economy is stratified with some sectors going gangbusters, other sectors barely above recessionary levels, whilst other sectors are in recession territory. I am reminded that recession indicators are based on models produced using historical data – and significant annual revisions by US Census, BLS, and the BEA change how we interpret the data.

The Federal Reserve has begun reducing the federal funds rate. EconCurrents follows the Federal Reserve Bank of Atlanta’s Underlying Inflation Dashboard which uses data from the US Bureau of Economic Analysis, the Federal Reserve Bank of San Francisco, and the Federal Reserve Bank of Dallas. Inflation has modestly declined over the last 7 months but, interestingly, the downward movement in some of the measures of inflation released in September were matched by upward movement of others.  Inflationary pressures remain high.

Our index’s design is to forecast Main Street growth, whilst Gross Domestic Product (GDP) is not designed to focus on the economy at the Main Street level. At this point, I expect the Main Street economy to be little changed in the fourth quarter of 2024 with the weak growth seen so far in 2024 continuing.

There are two flags indicating a recession – a yield curve inversion and the Sahm Recession Indicator. Last month, we removed the recession flag of the Business Activity ISM US Services Activity Index – and this month we have removed truck transport employment. It is important to understand that the ISM US Services Activity Index is at a level were recessions can occur.

Note that the quantitative analysis that builds our model of the economy does not include housing, personal income, or expenditures data sets.

Many graphs in this post auto-update so the words used in this forecast may not match the graphics. The Richmond Fed produces a PDF file with a current set of the US National Economic Indicators [click here to view this PDF].

This post will summarize the:

• special indicators,
• leading indicators,
• predictive portions of coincident indicators,
• review of the technical recession indicators, and
• interpretation of our index – EconCurrents Economic Index (EEI) – which is built of mostly non-monetary “things” that are indicative of the direction of the Main Street economy at least 30 days in advance.

Special Indicators:

There was significant revision to PCE data this past month that normalized the ratio between spending and income. The consumer is now showing historically normal spending to income ratios.  Note that the spending ratio currently has changed little in the last 10 months.

Seasonally Adjusted Spending’s Ratio to Income (an increasing ratio means the Consumer is spending more of Income)

if the above graph does not appear [click here] to view

The St. Louis Fed produces a Smoothed U.S. Recession Probabilities Chart that currently does not indicate an oncoming recession.

Smoothed recession probabilities for the United States are obtained from a dynamic-factor markov-switching model applied to four monthly coincident variables: non-farm payroll employment, the index of industrial production, real personal income excluding transfer payments, and real manufacturing and trade sales. This model was originally developed in Chauvet, M., “An Economic Characterization of Business Cycle Dynamics with Factor Structure and Regime Switching,” International Economic Review, 1998, 39, 969-996. (http://faculty.ucr.edu/~chauvet/ier.pdf)

if the above graph does not appear [click here] to view

Sahm Recession Indicator signals the start of a recession when the three-month moving average of the national unemployment rate (U3) rises by 0.50 percentage points or more relative to its low during the previous 12 months. This index remains higher than normal for a period of economic expansion – and is currently indicating a coming recession.

if the above graph does not appear [click here] to view

The Perkins Rule suggests a recession is imminent when monthly payrolls decline. Unlike other indicators, the Perkins Rule focuses solely on negative monthly payroll reports. At this point, the U.S. economy continues to add jobs which suggests a recession is not eminent.

if the above graph does not appear [click here] to view

EconCurrents reviews the relationship between the year-over-year growth rate of non-farm private employment and the year-over-year real growth rate of retail sales. This index remains in negative territory which is indicative of weak economic growth (a 1:1 correlation between employment growth and retail sales growth should minimally be expected). This suggests that the working consumer is not financially as well off as they were pre-2022. When retail sales grow faster than the rate of employment gains (above zero on the below graph) – a recession is not imminent. However, this index has many false alarms.

Growth Relationship Between Retail Sales and Non-Farm Private Employment – Above zero suggests economic expansion

if the above graph does not appear [click here] to view

The growth rate of real gross domestic product (GDP) is the headline view of economic activity, but the official estimate is released with a delay. Atlanta’s Fed GDPNow forecasting model provides a “nowcast” of the official estimate before its release. EconCurrents does not believe GDP is a good tool to view what is happening at the Main Street level – but there are correlations.

Latest estimate: 3.1 percent — September 27, 2024

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2024 is 3.1 percent on September 27, up from 2.9 percent on September 18. After recent releases from the US Census Bureau, the US Bureau of Economic Analysis, and the National Association of Realtors, a decline in the nowcast of real personal consumption expenditures growth was more than offset by increases in the nowcasts of real gross private domestic investment growth and the contribution of net exports to third-quarter real GDP growth.

The New York Fed also publishes a real-time GDP estimate called Nowcast.  The black line in the chart below represents the evolution of the Staff Nowcast, with the diamonds indicating the point estimate at each update, based on information available at that time.

A yield curve inversion historically has been an accurate predictor of an impending recession. A yield curve inversion is where short-term bonds have a higher yield than longer-term bonds. The graph below shows inversions before the US recessions. EconCurrents does not believe the yield curve is a reliable indicator of recessions in the New Normal where monetary policy uses extraordinary tools – but like a stopped clock, it can be correct at times. But note that a recession normally begins after the yield curve recovers into positive territory. Note that the yield curve remains deep in inversion – and is a recession flag.

if the above graph does not appear [click here] to view

Asset prices have been driven by liquidity. Measuring liquidity (blue line on the graph below) should be a good indicator of inflation. This graph currently indicates that the Consumer Price Index (CPI) rate of moderation should continue to be little changed (red line on the graph below). The bottom line here is that liquidity (blue line on the graph below) remains elevated and this puts upward pressure on inflation.

if the above graph does not appear [click here] to view

Continuing the discussion on inflation, it is now beginning to take up a sizeable chunk of the federal budget. Unfortunately, the graph below is updated only quarterly – and is now complete through 1Q2024. It does show that in 2Q2024 16.3% of federal expenditure went to interest payments on debt – up from 1Q2024’s 16.1%. It is not a major deal yet but could be if it starts approaching the previous high of 23.5% in 1Q1991.

if the above graph does not appear [click here] to view

The Leading Indicators:

The leading indicators are for the most part monetary-based. EconCurrents’ primary worry in using monetary-based methodologies to forecast the economy is that monetary policy is affecting historical relationships. EconCurrents does not use data from any leading indicator in its economic index. Leading indices in this post look ahead six months – and are all subject to backward revision.

The Conference Board’s Leading Economic Indicator (LEI) – the LEI has historically begun contracting well before a recession but has had many false contractions. What The Conference Board states:

… the US LEI remained on a downward trajectory and posted its sixth consecutive monthly decline. The erosion continued to be driven by new orders, which recorded its lowest value since May 2023. A negative interest rate spread, persistently gloomy consumer expectations of future business conditions, and lower stock prices after the early-August financial market tumult also weighed on the Index. Overall, the LEI continued to signal headwinds to economic growth ahead. The Conference Board expects US real GDP growth to lose momentum in the second half of this year as higher prices, elevated interest rates, and mounting debt erode domestic demand. However, in the Fed’s September 2024 Summary of Economic Projections, policymakers suggested 100 basis points of interest rate cuts are likely by the end of this year, which should lower borrowing costs and support stronger economic activity in 2025.

File: lei1.png

The nonfinancial leverage subindex of the National Financial Conditions Index – a weekly index produced by the Chicago Fed signals both the onset and duration of financial crises and their accompanying recessions. EconCurrents now believe this index may be worthless in real-time as the amount of backward revision is excessive – so we present this index for information only. This index was designed to forecast the economy six months in advance. The chart below shows the current index values and a recession usually occurs months to years after the trend line changes from negative to positive.

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Predictive Coincident and Lagging Indicators

Here is a run-through of the most economically predictive coincident indices which EconCurrents believes can give up to a six-month warning of an impending recession – and do not have a history of producing many false warnings. EconCurrents does not use any of these indicators in its economic forecast. Consider that every recession has different characteristics and dynamics – and a particular index may not contract during a recession, or start contracting after the recession is already underway.

Truck transport portion of employment – to search for impending recessions. Look at the year-over-year zero growth line. For the last two recessions, it has offered a six-month warning of an impending recession with only one false warning. Transport is an economic warning indicator because it moves goods well before final retail sales occur. Until people stop eating or buying goods, transport will remain one of the primary economic pulse points. When this sector turns robotic in the coming years – this measure will become useless – but currently, the shift from box stores to e-commerce is creating much more employment in this sector. Either way – this index may not be capable of alerting the next recession. Transport employment growth now rose slightly above the zero growth line. As transport provides a six-month recession warning – the implication was that any possible recession would have began in the first quarter of 2024.

if the above graph does not appear [click here] to view

Business Activity ISM US Services Activity Index – This index is noisy. The index is at 53.3 (below 55 is a warning that a recession might occur, whilst below 50 is almost proof a recession is underway). This index may not provide timely warnings of recessions – and is now in the levels that indicate a recession might occur.

File: ism.png  source: https://tradingeconomics.com/united-states/ism-non-manufacturing-business-activity

US Treasury Tax Receipts – Tax receipts’ year-over-year growth generally goes negative during a recession. Currently, tax receipts’ year-over-year growth is now in positive territory.

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Census Bureau Index of Economic Activity – The U.S. Census Bureau Index of Economic Activity (IDEA) is an aggregation of 15 of the Census Bureau’s primary economic data series that provides a single time series constructed as a weighted average. The current value is slightly positive which indicates the economy is growing slightly above the historical rate of growth.

idea.png

My favorite coincident indicator is the Chicago Fed National Activity Index (CFNAI) – a monthly index designed to gauge overall economic activity and related inflationary pressure. The index is a weighted average of 85 indicators of growth in national economic activity drawn from four broad categories of data: 1) production and income; 2) employment, unemployment, and hours; 3) personal consumption and housing; and 4) sales, orders, and inventories. Economic forecasting uses the 3-month moving average (blue line on the graph below). GDP is the red line on the graph below. A recession is likely to occur if the 3-month moving average falls below -0.7. This index is currently well above levels associated with recessions but indicates weak economic growth.

if the above graph does not appear [click here] to view

Technical Requirements of a Recession

Sticking to the current technical recession criteria used by the NBER:

The NBER’s traditional definition of a recession is that it is a significant decline in economic activity that is spread across the economy and that lasts more than a few months. The committee’s view is that while each of the three criteria—depth, diffusion, and duration—needs to be met individually to some degree, extreme conditions revealed by one criterion may partially offset weaker indications from another. For example, in the case of the February 2020 peak in economic activity, we concluded that the drop in activity had been so great and so widely diffused throughout the economy that the downturn should be classified as a recession even if it proved to be quite brief. The committee subsequently determined that the trough occurred two months after the peak, in April 2020. 

… The determination of the months of peaks and troughs is based on a range of monthly measures of aggregate real economic activity published by the federal statistical agencies. These include real personal income less transfers (PILT), nonfarm payroll employment, real personal consumption expenditures, wholesale-retail sales adjusted for price changes, employment as measured by the household survey, and industrial production. There is no fixed rule about what measures contribute information to the process or how they are weighted in our decisions.

Data for all indicators can be found and downloaded from FRED, the data website maintained by the Federal Reserve Bank of St. Louis. These data series have been collected on a single webpage. However, I have created a graph below looking at the month-over-month change (note that multipliers have been used to make changes more obvious).

Month-over-Month Growth Personal Income minus transfer payments (blue line), Employment (red line), Industrial Production (green line), Business Sales (orange line)

if the above graph does not appear [click here] to view

In the above graph, if a line falls below 0 (black line) – that sector is contracting from the previous month. Three sectors are in positive territory with the retail sales in negative territory.  Another way to look at the same data sets is in the graph below which uses indexed real values from the trough of the Great Recession.

Indexed Growth Personal Income minus transfer payments (red line), Employment (green line), Industrial Production (blue line), Business Sales (orange line)

if the above graph does not appear [click here] to view

EconCurrents believes that the New Normal economy has different dynamics than most economic models are using.

Economic Forecast Data

The EconCurrents Economic Index (EEI) is designed to spot Main Street and business economic turning points. The three-month rolling index value is a negative 0.03 – up modestly from last month’s slightly revised -0.10. The economic forecast is based on the 3-month moving average as the monthly index is very noisy. A positive value of the index represents Main Street’s economic expansion. Readings below 0.40 indicate a weak economy, while readings below 0.0 indicate contraction. It is not unusual for a dip below zero as the Main Street economy is more volatile – and it would take several months of contraction or a significant contraction to signal a recession.

The EEI is a non-monetary-based economic index that counts “things” that are indicative of the direction of the Main Street economy. Note that the EconCurrents Economic Index is not constructed to mimic GDP (although there are correlations, the turning points may be different), and tries to model the economic rate of change seen by businesses and Main Street. The vast majority of the inputs to this index use data not subject to backward revision.

The red line on the graph above is the 3-month moving average.

Consumer and business behavior (which is the basis of the EEI) either leads or follows old-fashioned industrial age measures such as GDP depending on the primary dynamic(s) driving the economy. The Main Street sector of the economy lagged GDP in entering and exiting the 2007 Great Recession.

As EconCurrents continues to backcheck its model, from time to time slight adjustments are made to the data sets and methodology to align it with the actual coincident data. To date, when any realignment was done, there have been no changes for trend lines or recession indications. Most changes to date were to remove data sets that had unacceptable backward revisions, became too volatile, or were discontinued.

Analysis of Economic Indicators:

EconCurrents analyzes all major economic indicators and summarizes them in our daily newsletter [sign up here]. The table below contains hyperlinks to the publisher of the indicator. The right column “Predictive” means this particular indicator has a leading component (usually other than the index itself) – in other words, has a good correlation to future economic conditions.