The long-leading indicators are positive.Business-related softness in the leading numbers continues.There is weakness in the jobs market and industrial production.
The purpose of the Turning Points Newsletter is to look at the long-leading, leading, and coincidental economic data to determine if the economic trajectory has changed from expansion to contraction — to determine if the economy has reached a “Turning Point.”
My recession probability in the next 6-12 months is 25%. There is a negative feedback loop in the business sector: weaker sentiment has caused a decline in new orders for capital goods, which has lowered the average weekly hours worked of production workers along with industrial production. Bond traders have picked up on this, inverting the yield curve. We are also seeing a weaker jobs data.
Below are four charts showing the key data:
The top two charts show corporate profits. The left chart shows the absolute level while the right chart shows the Y/Y percentage change. This data series returned to profitability in the last report. The lower left chart shows that BBB yields are very low while the right chart shows M2’s Y/Y percentage growth. Combined, the charts indicate that there is no stress in the financial system while the Fed is pumping liquidity into the economy.
The long-leading indicators are positive.
Let’s start with the positive data:
The top two charts show new orders for consumer durable goods. The absolute number (left chart) recently hit a cycle high while the Y/Y percentage change (right chart) is positive. The short-term credit markets (lower left; 3-month commercial paper minus the federal funds rate) are very liquid while the 4-week moving average of initial unemployment claims (right chart) is very low.
The manufacturing sector, however, continues to have problems. First of all, the ISM PMI recently entered contraction territory:
The Markit Economics US Manufacturing PMI is trending lower as well:
And the regional surveys have been trending lower for the last year:
This is being caused by soft data in the new orders for durable goods in non-transportation orders:
The absolute level has been trending sideways for the last year (left chart) which has caused the Y/Y percentage change to turn negative (right chart).
There has been a consistent decline in the new orders for machinery (in blue), computers (in red), and primary metals (in green).
Right now, manufacturers are coping with this trend by lowering the weekly hours worked of production workers:
Average weekly hours have been declining for the last year.
Finally, there is the yield curve:
Several measures of the belly of the curve (the 1-10 year area) have been inverted for at least five months (left chart).
There is also a broader inversion between the 10-year and 3-month Treasury:
Leading Indicator Conclusion: There is a clear series of weaker readings in the business sector: weaker orders are causing declining production, which is leading manufacturers to cut weekly hours worked. That, combined with the yield curve’s contraction, goes a long way to explaining my 25% recession probability in the next 6-12 months.
This past week, the BLS released the latest employment report, which had a 130,000/month headline print. To eliminate the monthly noise, I use the 3, 6, and 12-month moving average of the monthly gains in establishment jobs:
Data from the St. Louis Federal Reserve; author’s calculations
The 3-month moving average (in blue) is near its lowest level in five years. The 6-month moving average (in gold) is as well while also declining at its sharpest rate in the same time period.
And industrial production has been trending weaker over the last year:
The left chart shows the absolute level, which started to decline in the 4th quarter of 2018. The Y/Y percentage number (right chart) has been trending lower and is nearing a contraction.
Coincidental data: there is softness in the establishment job numbers as well as industrial production (see above for commentary on the business sector). It’s possible that as unemployment has continued to decline it’s become harder to find employees, causing the decline in hiring. But it’s also possible that business is simply more cautious as they grow more concerned about a slowing economy and the negative impact of the trade war.