(Editor's Note: In each quarterly issue of "U.S. Business Cycle Barometer," we highlight and comment on key economic activity data, and we evaluate their potential relevance for risks to expansion.)
S&P Global Economics' recession model, which is based on key financial market indicators up to mid-November, indicates that the probability of a recession starting in the coming 12 months has moved down to 30%. The probability of recession risk based on this model was 35% in August (see chart 1).
A key driver of our recession model, the term spread (10-year minus three-month Treasury rates), which had been negative since late May, reversed its trajectory to become positive in mid-October (see chart 2). The yield curve returns to being positively sloped, leading the upturn by five to 15 months (excluding the Great Recession). However, since the average recession lasted only 10 months during the postwar period, the lead has been of little use for forecasting periods. The yield curve returned to being positively sloped before the last three recessions began.
The "un-inverting" of the yield curve is a reflection of easing of three issues that had heightened investors concerns around midyear.
First, the escalation in trade talks between the U.S. and China has eased some. A possible "phase 1" deal is reportedly in the works. However, we caution the details are yet to be announced and chances of a reversal in sentiment are still elevated.
Second, there are tentative signs that the deterioration in manufacturing may be coming to an end. As an early sign of bottoming out, the sector eeked out slightly positive real output growth in the third quarter following two consecutive quarters of decline--even while business manager sentiments are unfavorable. Still, unless we see a material pickup in orders in the coming months, we hesitate to say a definite upswing is in place. After all, headwinds to manufacturing from slower global growth remain.
Third, and most importantly, the Federal Reserve cut policy rates two more times (25 basis points each) since our August publication, bringing down its policy rate to 1.5%-1.75%. In the midyear yield curve inversion, markets showed their preference that likely reflected a belief that the equilibrium real neutral rate has fallen to near zero (compared with the 0.5% median Fed estimate), which was in tandem with an increased likelihood of slower growth and lower inflation for longer.
Financial markets signaled they expected a downturn if the Fed didn't respond by cutting its short-term policy rates, and the Fed promptly got ahead of that by making 75 basis point insurance cuts. The accommodation by the Fed reassured financial markets that the Fed will lean against increased downside risks to provide a growth buffer. It also helped stabilize the housing sector, with building permits reporting significant gains.
Leading Indicators Of Near-Term Growth
Because Federal Open Market Committee (FOMC) members have said that they are data-dependent, incoming economic and financial data will affect FOMC decisions. By the same token, we are monitoring upcoming data to gauge signals, which could affect our recession call.
Our dashboard of leading indicators of near-term growth didn't deteriorate since our last publication (see table). Out of 10 leading indicators of near-term U.S. economic growth that we like to look at, three indicators are positive for growth, five are neutral, and two are negative. Since our report in August, the term spread and single-family building permits turned neutral from negative, and the Institute for Supply Management (ISM) Manufacturing New Orders Index turned negative from neutral.
The incoming economic data has been on the weaker side in manufacturing compared with last year, albeit above recessionary levels. The sector's orders (leading indicator of production activity in the coming months) have been hit by global weakness, the General Motors strike, and Boeing's woes. The ISM Manufacturing New Orders Index turned contractionary (below 50) since we last published (see chart 3). This channel is likely to be negative for growth in the next few months.
On the other hand, building permits have clearly bottomed out and started to move back up (see chart 4). The growth signal now is neutral (and leaning positive). Permits jumped by 5% month over month to 1.46 million annualized in October, a 12.5-year high, stemming from:
- An increase in multifamily units and
- The more important single-family permits--the best measure of underlying housing demand--which increased for the sixth consecutive month to 909,000.
Growth in building permits has outpaced starts in recent months, pointing to a sizable number of projects in the pipelines. The 30-year fixed mortgage rate has increased in recent weeks, but it remains below 4%. And, after approaching 5% in late 2018, it is a very attractive rate that is pulling potential first-time buyers off the sidelines. The National Association of Home Builders Housing Market Sentiment Index remained elevated at 70 in November, pointing toward continued increases in new single-family home sales.
The easing in the six-month growth rate of the OECD's leading indicator composite index resembles the temporary slowdowns of 2012 and 2016 rather than the sharper declines during historical recessions.
Viewed through a multiple outcome framework, the composite leading indicator, combined with the dispersion of sectoral drivers of growth in activity within the economy, still suggests elevated odds of weaker growth in the coming six months. But, they have eased somewhat since their local peak in the first quarter.
While we do not see clear evidence of a larger slowdown already taking hold that is worse than the economy working through a long-anticipated growth slowdown (transitioning from a near 3% to a near 2% economy), the variance on timing and scope of the slowdown has increased.
Where Do The Coincident Indicators Stand?
Collectively, the coincident indicators from the Conference Board suggest the economy still has room to grow as it flirts with the late-cycle stage of expansion. Compared with the average of the prior six cycles, all four key indicators continue to depict smaller cumulative growth in the current cycle from the previous peak. As such, signs of overheating in the broader economy are scant. That said, a comparison of the performance of coincident indicators with previous expansions benchmarked at this stage of the business cycle using the output gap (i.e., an estimated output gap of +0.8%, as opposed to their peaks) yields a smaller gap compared with previous cycles.
The views expressed here are the independent opinions of S&P Global's economics group, which is separate from, but provides forecasts and other input to, S&P Global Ratings' analysts. The economic views herein may be incorporated into S&P Global Ratings' credit ratings; however, credit ratings are determined and assigned by ratings committees, exercising analytical judgment in accordance with S&P Global Ratings' publicly available methodologies.
|U.S. Chief Economist:||Beth Ann Bovino, New York (1) 212-438-1652;|
|U.S. Senior Economist:||Satyam Panday, New York + 1 (212) 438 6009;|
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