The Federal Reserve’s surprising decision yesterday to delay the start of slowing its asset purchases reflects continued wariness about the outlook for the economy. Although the central bank recognizes "that economic activity has been expanding at a moderate pace," the Federal Open Market Committee explained in its statement that it "decided to await more evidence that progress will be sustained." In fact, the evidence is compelling for arguing that the latest profile of economic activity continues to suggest that business cycle risk is low. That’s the message in today’s update of the Economic Trend (ETI) and Momentum indexes (NYSEMKT:EMI). Both benchmarks, which measure the broad trend in the economy via 14 economic and financial indicators, reflect values that are well above their respective danger zones. That’s a sign for anticipating that the NBER will not declare August as the start of a new recession.
Indeed, most of the indicators in ETI and EMI continue to trend positive. The one exception is the year-over-year comparisons for crude oil prices of late, which translates into a drag on the current macro conditions. Otherwise, the broad profile of economic activity remains positive in terms of assessing business cycle risk via the current numbers.
Here's a closer look at how the various indicators for ETI and EMI compare in recent months:
Reviewing ETI and EMI in historical context shows that both benchmarks remain well above their respective danger zones: 50% for ETI and 0% for EMI. When the indexes fall below those levels, that will be a sign that recession risk is elevated.
Translating ETI's historical values into recession-risk probabilities via a probit model also suggests that business cycle risk is low.
Let's also review the near-term outlook for ETI by predicting future values with an econometric technique known as an autoregressive integrated moving average (ARIMA) model. The ARIMA model estimates the missing data points for each indicator, for each month through October 2013 (June 2013 is currently the latest month with a complete data set). Based on this projection, ETI is expected to remain well above its danger zone in the near term. Forecasts are always suspect, of course, but recent projections of ETI for the near term have proven to be relatively reliable guesstimates vs. the full set of monthly reported numbers that followed. As such, the latest projections (the four tan-colored bars on the right) offer some support for cautious optimism. For comparison, the chart below also includes ARIMA projections published on these pages in previous months, which you can compare with the complete monthly sets of actual data that followed, based on the latest data (red circles). The assumption here is that while any one forecast is likely to be wrong, the errors may cancel one another out to some degree by aggregating a broad set of forecasts.
For additional context, here are previously published ETI and EMI updates for the last three months: