The US economy’s forward momentum remained sluggish in August.
Although recession risk was low last month, a series of disappointing indicator updates in recent weeks suggest that the macro trend continues to struggle.
The latest set of releases deals a setback to recent projections for modestly firmer economic activity for the near term. The August profile for the broad trend reveals that several key indicators have either slipped deeper into the red (industrial production(NYSEARCA:XLI)) or posted declines for the first time in recent months (ISM Manufacturing Index and residential building permits).
The numbers overall continue to reflect a low probability that August marks the start of an NBER-defined recession. Nonetheless, the case has weakened for expecting that the economy is about to break free of the sluggish growth trend that’s prevailed in recent quarters. Today’s revised outlook marks a mild setback from last month’s update, which highlighted the possibility for a near-term firming in the trend.
Indeed, as the table below shows, there’s a bit more red ink in the latest monthly column of indicators, which trimmed the Economic Trend Index (ETI) slightly in the preliminary August reading vs. July. The Economic Momentum Index (EMI), however, ticked up last month. (See note at the end of this post for ETI/EMI design rules.) In any case, recession risk remains low and is expected to remain so for the near term. The analysis is based on a methodology outlined in Nowcasting The Business Cycle: A Practical Guide For Spotting Business Cycle Peaks. Here’s a summary of recent activity for the components of ETI and EMI:
Aggregating the current data in the table above into business cycle indexes shows that both benchmarks are still above their respective danger zones: 50% for ETI and 0% for EMI. When the indexes fall below their respective tipping points, we’ll have clear warning signs that recession risk is at a critical level, in which case a new downturn is likely.
Translating ETI’s historical values into recession-risk probabilities via a probit model also points to low business-cycle risk for the US through last month.Analyzing the data with this methodology shows that the numbers still imply that the odds are low that the National Bureau of Economic Research (NBER) — the official arbiter of US business cycle dates— will declare August as the start of a new recession.
For perspective on looking ahead, consider how ETI may evolve as new data is published. One way to project future values for this index is with an econometric technique known as an autoregressive integrated moving average (ARIMA) model, based on calculations via the “forecast” package for R, a statistical software environment. The ARIMA model calculates the missing data points for each indicator and for each month–in this case through October 2016. (Note that June 2016 is currently the latest month with a complete set of published data.) Based on today’s projections, ETI is expected to remain above its danger zone for the near term by holding above the 50% mark. (Keep in mind that business cycle updates are available on a weekly basis in The US Business Cycle Risk Report.)
Forecasts are always suspect, of course, but recent projections of ETI for the near-term future have proven to be relatively reliable guesstimates vs. the full set of published numbers that followed. That’s not surprising, given the broadly diversified nature of ETI. Predicting individual components, by contrast, is prone to far more uncertainty. The current projections (the four black dots on the right in the chart above) suggest that the economy will continue to expand. Note, however, that the previous estimate for a relatively solid improvement for September’s ETI has subsequently been trimmed by a substantial degree since last month’s update and the October project is currently expected to be even softer.
The chart above also includes the range of vintage ETI projections published on these pages in previous months (blue bars), which you can compare with the actual data that followed, based on current numbers (red and black dots). The assumption here is that while any one forecast for a given indicator will likely miss the mark, the errors may cancel out to some degree by aggregating a broad set of predictions. That’s a reasonable view according to the historical record for the ETI forecasts.
For additional perspective on judging the track record of the forecasts, here are the previous updates for the last three months:
Note: ETI is a diffusion index (i.e., an index that tracks the proportion of components with positive values) for the 14 leading/coincident indicators listed in the table above. ETI values reflect the 3-month average of the transformation rules defined in the table. EMI measures the same set of indicators/transformation rules based on the 3-month average of the median monthly percentage change for the 14 indicators. For purposes of filling in the missing data points in recent history and projecting ETI and EMI values, the missing data points are estimated with an ARIMA model.