With the current U.S. economic expansion hitting record-setting territory, economic anxiety is setting in for some as the Fed eyes a rate cut. Financial Sense Insider spoke with Nick Reece, senior financial analyst at Merk Investments, to discuss his recent chart pack and to get his take on leading economic indicators.
Conference Board’s U.S. Leading Economic Index
Based on this Index, Reece stated, the picture is still positive. His chart shows the year-over-year rate of change, and when this goes negative, it tends to suggest a high probability of an upcoming recession. However, right now the year-over-year rate of change is still positive at 2.5%.
We do see a decelerating rate of change on a year-over-year basis, which could suggest it may go negative in the coming months. However, Reece noted, he sees the index level making new all-time highs and new highs for the cycle, which leaves him generally optimistic.
This chart shows U.S. growth is still positive, growing at 2.5% year-over-year, though it is decelerating. Overseas weakness may be a concern, with four of the five leading countries currently showing contractionary conditions, however, the trend in the U.S. is still up, Reece explained.
Trade Is A Wild Card
What impact would a slowdown overseas have on the U.S.? Fortunately, the U.S. is not dependent on trade, Reece noted, and the U.S. is still the largest economy in the world. It does have an impact on expectations. Also, U.S. manufacturing PMIs have been trending lower with this global picture.
“Looking at the election calendar, I think people are pretty well aware that oftentimes election outcomes tend to correlate strongly with the direction of the economy and the equity market going into the election as to whether the incumbent remains in office or not,” Reece said. “So I think that Trump’s going to do what he can to keep this expansion going through next November’s election.”
Powell’s Dual Mandate
Fed. Chairman Jerome Powell has clearly stated his intent to keep the economic expansion going.
Powell likely has it in mind to get back to those peaks, Reece stated, and lower the U3 number. The U3 number signifies the number of people actively seeking a job and is released each month by the Bureau of Labor Statistics. The U3 doesn’t show the entire picture when it comes to current levels of unemployment; it excludes the number of discouraged, underemployed and unemployed workers in the country.
The other half of the Fed’s dual mandate for price stability doesn’t appear threatened here and increasing the participation rate may be important for Powell.
“I think that Powell would really like to see this unemployment rate continue to trend lower or at least not trend higher, but to also get the participation rate up,” Reece said. “Mathematically, it’s easier for the U3 to go up if the participation rate is going up. But clearly having the participation rate go up is a positive sign for the economy. One thing that would get me nervous is if we see this U3 rate starting to turn and trend higher with labor force participation declining, and we haven’t seen that yet.”
Third Quarter, GDP and the Yield Curve
The Atlanta Fed GDP Now forecast is currently at 1.3%. Though it is a lower projection, Reece noted, it is still positive. If we get something in between one and two percent for the second quarter, we would continue to see that downtrend.
But, as in the negative blip seen in the quarterly annualized growth rate reading of GDP for the second quarter of 2014, Reece noted, one quarter of bad data isn’t necessarily something that we can infer too much from.
The 10-year minus the three-year is still positively sloped, but the 10-year minus the three-month has been inverted for a few months and is currently around negative 20 basis points. One cut might be enough to reverse the inversion of the the 10-year minus the three-month, Reece noted. With inflation running under control, this is the logical step for the Fed, he added.
“There’s an argument that the Fed can do some rate cuts here without too much fear of inflation overheating,” he said. “That’s pretty similar to the pattern that we saw in the late 1990s, following the 1998 rate cuts.”
Recession Odds Elevated?
The New York Fed’s chart of recession probability shows the likelihood of recession as high as it’s been since the 2008 to 2009 timeframe.
However, Reece does not want to extrapolate from this that we’re likely to see a blow-off top in equities. It is a possibility, he noted, but we’re likely to see the S&P 500 trend higher.
“I do think we have to acknowledge the risk of tipping over into a recession is elevated. This data bears a very close watching. I can envision three to six months from now being a very clear picture that we’ve weathered the storm. I could also easily envision it being the case that we’re pretty clearly tipping over into recession.”