On Friday last week the US Conference Board released their leading economic indicator for January 2012, which rose for the fourth consecutive month.
This is also a useful opportunity for us to provide an updated assessment of some of the key leading/activity indicators applicable to the US economy. These include the US Conference Board Leading Economic Indicator, the Chicago Federal Reserve National Activity Index, the Federal Reserve’s Yield Gap Model, the ISM manufacturing index, the ECRI Leading Indicator (weekly) as well as the Bloomberg consensus forecast of US quarterly GDP. Charts on all of these indicators have been updated, and are attached.
The Chicago National Activity Index has improved noticeably in recent months. The 3-month average index is at -0.08, which is a vast improvement on the -0.5 recorded in June 2011 (anything worse than -0.7 is considered to reflect a possible recession). The next data point is due for release on Tuesday, and is expected to improve further.
The yield gap, which is normally a very reliable and accurate indicator of future economic activity is obviously heavily distorted by the very unusual monetary policy in the US, and therefore not necessarily a good indicator of economic conditions over the next 6 to 12 months. Nevertheless, using a model developed by one of the research analysts within the US Federal Reserve, the US interest rate spread is reflecting a 0% chance of a US recession within the next 12 months.
The Conference Board’s leading indicator rose by 0.4%m/m in January, following a 0.5%m/m increase in December and a 0.3%m/m improvement in November. Furthermore, the indicator has recorded positive growth in 10 of the last 12 months. The two months of decline during the past year occurred in August and September 2011, reflecting a weak patch in the path of the current economic recovery; but not a return to recession conditions.
The ISM manufacturing index, which has historically been a very reliable indicator of US business cycle conditions, has given a number of false signals in recent years. This was arguably the case in early to mid-2011, however, the index remained above the key 50 level throughout 2011. The index has since improved to 54.1 in January 2012.
The ECRI indicator has also improved in recent weeks. Unfortunately, some recent research pieces have questioned the credibility of the ECRI’s process. In September 2011, the institute became emphatic that the US economy was about to experience a “double-dip” recession and embarked on a media blitz to publicise their “unmatched ability to forecast cycle turning points”. Instead, economic activity has improved and economic forecasts have been revised up. I don’t have access to their research reports, but will continue to monitor the weekly index reading. While we don’t expect the US economy to return to recessionary conditions this year, there are some downside risks which need to be closely monitored.
The latest consensus (Bloomberg) quarterly GDP forecast for the US (compiled last week) is also not suggesting a return to recession conditions. Furthermore, the forecasts have once again been revised up. This applies especially to the more pessimistic within the forecast range.
According to the Chief Economist at the Conference Board: “the gain in the Leading Economic Indicator during January reflected fairly widespread strength among its components, pointing to somewhat more positive economic conditions in early 2012. The leading indicator’s increase in January was led not only by improving financial and credit indicators, but also rising average workweek in manufacturing. These both offset consumers’ outlook about the economy, which remained pessimistic, though slightly less so. Recent data reflect an economy that started the year on a positive note. The Leading Indicator suggests these conditions will continue and could possibly even pick up this spring and summer.”
The composition of the US leading indicator was recently revised (see chart attached for the current weights). In terms of these changes, the Conference Board has pointed out that financial indicators such as yield curves and stock prices have been extensively used as leading indicators of economic activity due to their forward looking content. However, the coverage of financial and credit market activity can be improved to account for some of the structural changes in the US economy (especially in financial markets).
Over the past three decades, many new financial indicators, such as interest rate swaps, credit default swaps, certain corporate-treasury spreads, the Federal Reserve’s senior loan officer survey, etc, have become available, but, since most of these new indicators have not been available for a long enough period, very little research has been conducted to evaluate their usefulness as leading indicators. The Conference Board research indicates that several of these financial indicators rank highly according to their ability to predict recessions.
These financial indicators have been aggregated into a single composite index, named the Leading Credit Index, and incorporated as a component in the revised Leading Indicator, replacing real money supply (M2).
Overall, it is fair to say that all of the US leading/activity indicators we examine have improved measurably in the past few months, suggesting an improvement in the outlook for the US economy, relative to August/September 2011. Consequently, the recent upward revision to the consensus US economic forecast for 2012, especially by the more pessimistic forecasters, appears appropriate.
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