This week’s edition of Simply put focuses on a quant conundrum related to our indicators: our US growth indicator remains firmly at low levels. Is it a false signal? Should we reconsider the indicator itself?

 

Need to know: Our US growth nowcaster has been in decline for some time. This is usually a tell that a recession is brewing in the economy Hard data shows a different picture, revealing a very resilient economy outside of the housing sector Historically, our nowcasting indicator needs to be lower than 30% to diagnose a recession and we are currently around that threshold.  Stay tuned!

 

A resilient US economy?

Our regular readers must be well aware that our LOIM nowcasting indicators have been showing a deterioration in the growth cycle for quite some time now. Our understanding of that message seemed clear when the US growth nowcaster declined below the 45% threshold in the fourth quarter of last year, creating a natural conservative tilt to our asset allocation. All signs pointed to a recession maturing in the US economy. And yet, this week’s number again showed a resilient US economy. A lot has been written on the topic already, including from us, listing all the elements that explain the resilience of the US economy: excess savings, China’s reopening, and fiscal spending, among others.

Let’s run a comparison of the indicators’ behavior over the past three recessions to try assessing what level should effectively signal the onset of a recession.

 

Taking stock of our indicator

Figure 1 shows the daily evolution of our US growth nowcaster, alongside its diffusion index. The indicator reads as follows: it ranges from 100% (excellent growth) to 0% (very low growth) while its diffusion index shows the percentage of data which is improving.

The chart clearly highlights a macro deceleration in the US that started in June 2022 and that has continued since then. The percentage of improving data since then has remained below 50%, apart from a couple days in February 2023 and since the beginning of July. It was around 14 July that the percentage of improving data reached 57% - a large number, but not large enough to call a recovery just yet. The decomposition of the signal below shows how most type of data are pointing to slower activity, with the number one contributor being monetary conditions. Does this bleak growth picture show in the (hard) data?

 

Figure 1. US growth nowcaster and diffusion index daily evolution(left) and its decomposition (right)

Source: Bloomberg, LOIM

 

The hard data

The short answer is no. Figure 2 shows the rebased evolution of the different elements which make up US growth, from durable and non-durable consumption to service and investment (residential and non-residential). Globally, the goods-producing industry did see a flat evolution over 2022 but also an uptick during the first quarter of this year. The services industry has been trending up since its decline over the pandemic. Non-residential investment resumed its slow upwards trend that it has been exhibiting since 2008.

The only tell that something negative is brewing in the US economy is residential investment: there, the decline that started in the second quarter of 2022 (consistently with our nowcasting indicator) is now material and comparable in magnitude to that of the 1990 recession. Does this rosy situation call for a no-landing situation? Well, not quite: look at the chart and see how a decline in the housing market has preceded each of the past three recessions, to later trigger a drag in goods consumption. This is a first call for caution: what is happening today is probably less exceptional that it looks at first sight.

 

Figure 2. Rebased evolution of US real GDP growth (in log values)

Source: Bloomberg, LOIM

 

The historical recession threshold

This housing situation (in real terms) led us to investigate what level of our growth indicator usually indicates that a recession is about to start. Figure 3 shows how our indicator behaved over the 1990, 2001 and 2008 US recessions. We established 45% as the threshold at which we would shift our allocation away from equities and credit (markets are usually forward looking) for our macro risk premia strategy.  When it comes to dating recessions, a much lower threshold than that is needed.

Historically, our indicator has coincided with a recession in the US when it falls below 30%. It has been so across the past three recessions, and today’s values are close to that. It fell to 26% in June but is currently at 30.5%. From that perspective, it remains difficult to call the start of a recession in the US. We sit at the very threshold that will probably make a sharp difference in terms of investing for the next six months. Should we breach that level to reach much lower values, a recession will be very likely.

Should the current uptick remain solid and should growth improve in the coming quarters – this second possibility would again go the natural way of functioning of monetary policy - the singularity of the current situation opens the door to unexpected scenarios. One lesson we take from here: let’s keep a close eye on our growth indicator, as its evolution in the coming weeks could be a meaningful signal in terms of asset allocation.

 

Figure 3. Historical behavior of our US growth nowcaster around the past three recessions and today

Source: Bloomberg, LOIM

Simply put, the current level of our growth indicator would suggest a recession is not on the cards just yet. Its evolution over the next couple of weeks could provide meaningful information in terms of asset allocation.

 

 

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Macro/nowcasting corner

This section gathers the most recent evolution of our proprietary nowcasting indicators for world growth, world inflation surprises and world monetary-policy surprises. These indicators keep track of the most recent macro evolutions that make markets tick.

Our nowcasting indicators currently point to:

• The change in regime of our growth indicator has been confirmed by this new week of macro data: growth conditions have stopped improving recently. This essentially mirrors the deterioration in the European situation at the moment
• Little inflation-related information has been published this week and our inflation nowcasting indicator remains firmly anchored at low levels
• Both the Federal Reserve and the European Central Bank (ECB) gave confirmation of the message our monetary policy indicator is giving: central bank moderation is underway

 

World growth nowcaster: long-term (left) and recent evolution (right)

World inflation nowcaster: long-term (left) and recent evolution (right)

World monetary policy nowcaster: long-term (left) and recent evolution (right)

LOIM's nowcasting indicators gather economic indicators in a point-in-time fashion to measure the probability of a given macroeconomic risk - growth, inflation and monetary policy surprises. The Nowcaster ranges from 0% (low growth, low inflation and dovish monetary policy) to 100% (high growth, high inflation and hawkish monetary policy).

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