U.S. Business Cycle Risk Report - 18 November 2016

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Recession risk in the US remains low in the wake of several upbeat economic. Retail sales and residential housing construction in particular posted firmer numbers for October. Industrial output was flat last month, but the mildly negative annual trend continues to move closer to zero, driven by modest growth in the manufacturing sector. Meanwhile, the labor market still looks poised to expand. Payrolls continued to rise in October and growth looks poised to continue in the near term based on yesterday's news that jobless claims dropped to the lowest level since 1973.

The macro trend, in other words, remains solidly positive. October's economic profile is highly unlikely to mark the start of an NBER-defined recession. A similar narrative applies via the near-term projections through December. In fact, the Atlanta Fed yesterday (November 17) raised its fourth-quarter GDP nowcast to a solid 3.6% increase (seasonally adjusted annual rate). If the estimate holds, the US economy will expand at the strongest pace in more than two years.

The encouraging data is also showing up in The Capital Spectator's proprietary business-cycle indexes. As projected in previous months (see bottom chart here and here, for instance), US economic activity has rebounded after slowing in the first half of the year. Although there's still red ink in various components that comprise the benchmarks, the broad trend has improved lately and current projections suggest that the numbers overall will continue to skew positive through the end of the year, as shown in the last chart below. (Keep in mind that The Capital Spectator also monitors the macro trend across a broader set of data and analytics on a weekly basis in The US Business Cycle Risk Report in addition to this monthly update.)

Aggregating the data in the table above into business cycle indexes continues to reflect a broad trend that remains comfortably positive. The Economic Trend and Momentum indices (ETI and EMI, respectively) ticked up again vs. last month's update and both benchmarks remain moderately above their respective danger zones: 50% for ETI and 0% for EMI. When/if the indexes fall below those tipping points, we'll have clear warning signs that recession risk is at a critical level, in which case a new downturn is likely. The analysis is based on a methodology outlined in Nowcasting The Business Cycle: A Practical Guide For Spotting Business Cycle Peaks .

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 continue to imply that the odds are virtually nil that the National Bureau of Economic Research (NBER) - the official arbiter of US business cycle dates- will declare October 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. The ARIMA model calculates the missing data points for each indicator and for each month-in this case through December 2016. (Note that August 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.

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 ETI's design to capture the broad trend via a range of indicators. Predicting individual components, by contrast, is prone to far more uncertainty. The current projections (the four black dots in the chart above) suggest that the economy will continue to expand. Note, however, that the projections overall point to a trend that's expected to remain positive but at a moderate pace.

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:

20 October 2016
21 September 2016
25 August 2016

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.