U.S. Business Cycle Risk Report - 20 December 2016

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A modestly positive economic trend held US recession risk at a low level through November. Although recent updates revealed some unexpected weakness in last month's activity (retail sales and industrial production), the broad macro profile continues to reflect a growth bias that appears set to continue in the near term.

Data published to date strongly imply that November's economic profile is unlikely to mark the start of an NBER-defined recession. Corroborating evidence can be found in recent fourth-quarter GDP nowcasts from the Atlanta and New York Fed banks. Although the Q4 projections currently anticipate softer growth vs. Q3, the projected increases imply that a new recession is a low-probability threat at the moment.

A positive trend is also conspicuous in The Capital Spectator's proprietary business-cycle indexes. As projected earlier in the year (see bottom chart here and here, for instance), US economic activity has rebounded after a slowdown in the first half of 2016. Although red ink continues to weigh on some components (see table below) that comprise the benchmarks, the broad trend has improved lately and current projections (see last chart below) still point to modest growth in the immediate future. (Keep in mind that The Capital Spectator monitors the macro trend across a broader set of data and analytics on a weekly basis in The US Business Cycle Risk Report.)

tab-20dec2016

Aggregating the data in the table above into business cycle indexes continues to reflect a broad trend that remains solidly positive. The Economic Trend and Momentum indices (ETI and EMI, respectively) ticked higher in November 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 .

eti-emi-chart

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 November as the start of a new recession.

probit-eti-chart

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 January 2017. (Note that September 2016 is currently the latest month with a full 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.

eti-f-chart-2016-12-20

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 based on multiple indicators. Predicting individual components, by contrast, is prone to far more uncertainty. The assumption here is that while any one forecast for a given indicator will likely be wrong, the errors may cancel out to some degree by aggregating a broad set of predictions. That's a reasonable view according to the generally accurate historical record for the ETI forecasts.

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).

For additional perspective on judging the track record of the forecasts, here are the previous updates for the last three months:

18 Nov 2016
20 Oct 2016
21 Sep 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.