Economic Outlook

Last Update: April 2023

Bull and Bear Overview

Bull	Weight	Bear	Weight	Type	Level
China Reopening		Yield Curve	To add	Indicator	Severe
Inflation Declining		Housing Market		Data	Severe
Easing financial conditions		LEI Index		Indicator	Severe
		New Orders		Data	Bad
		Jobless Claim		Data	Mild

Leading Indicators

1. Yield Curve

Details: Yield Curve

Current data:

1. The 10Y2Y spread: Current inversion is around -49 bps, it has started to steepen again
2. The 10Y3M spread: Current inversion around -153 bps, worst inversion since the data series started.
3. Majority of the yield curve is inverted at this moment, this condition has always preceded a recession

The yield curve inversion is giving a signal that there is a high likehood that recession risks in the US economy are amplified significant for the second half of 2023 onwards. Historically recession has started when the yield curve steepens again after the maintained inversion.

2. Housing Market Activity

Details: Housing Market: US

Current data:

• Pending home sales in the United States decreased 21.1% year-on-year in February of 2023, following a 24.1% fall in January, and marking a 21st straight month of declines.
• Building permits in the US were revised higher to a seasonally adjusted annual rate of 1.55 million in February of 2023, from an initial estimate of 1.524 million. It remains the highest reading in five months
• The NAHB/Wells Fargo Housing Market index in the US increased for a third month to 44 in March of 2023, a new high since September of 2022 and beating market forecasts of 40.
• Real residential investment GDP on Q4 2022 was -26.7%

There is a high likelihood that the recession risks in the US economy are amplified significantly in Q2 2023 onwards due to housing market weakness, the activity has stabilized a bit recently, but numbers continue to deteriorate at a lower rate.

3. Conference Board Leading Index

Details: Conference Board Leading Index

Current Data:

The U.S. LEI fell to its lowest level since November of 2020, consistent with worsening economic conditions ahead

• The Conference Board Leading Economic Index for the U.S. fell by 1.2 percent in March 2023, following a decline of 0.5 percent in February. A -0.6% decline was expected.
• The LEI is down 4.5 percent over the six-month period between September 2022 and March 2023—a steeper rate of decline than its 3.5 percent contraction over the previous six months

• The recession signal was hit in August 2022.

The index criteria gave the recession signal on August 2022, and since then the index has deteriorated further. Given the track record of the index and the lead time of 7 months, risks of recession in the US economy are amplified significantly in Q2 2023 onwards.

4. New orders

Details: New Orders

Current data:

• The ISM Manufacturing New Orders subindex in the United States decreased to 44.3 in March of 2023 from 47 in February, as companies become more concerned about when manufacturing growth will resume
• The ISM Non Manufacturing New Orders subindex in the United States decreased to a three-month low of 52.20 points in March from 62.60 points in February of 2023
• New orders for manufactured durable goods in February, down three of the last four months, decreased $2.6 billion or 1.0 percent to $268.4 billion, the U.S. Census Bureau announced today. This followed a 5.0 percent January decrease.

The current data in new orders is in the contracting territory for manufacturing but not for services, however, both are in a downtrend. This points to weaker and contracting future output or production, especially in the manufacturing sector. New orders is considered more of a short term leading indicator, so we can expect the weakness to materialize in production in Q2 2023.

5. Jobless Claims

Details: Jobless Claims

Current data:

1. Initial jobless claims currently at 194,000. It is up 15% since the trough in March.
2. Continued jobless claims currently at 1,696,000. it is 30% since the trough in March.

In conclusion, even though at a historically low level, continuing jobless claims had already increased 30% since its lowest point in March 2021. In recent weeks the initial claims have stabilized and even decreased again, but continuing claims has stayed flat.

Assessment:

Some of the most prominent leading indicators used in this analysis show signs of significant deterioration and a high probability that the economy could enter a recession sometime after Q2/Q3 2023. Given China's reopening and the demand this will bring to the global economy, since China is the second largest economy in the world, it could slow the rate of contraction the economy is already experiencing, acting as a positive shock in the short term.

Also the recent rebound on financial conditions and some of the economic numbers could create some tailwind in growth in the very short term, and a delayed of weakness, however, in my opinion, this don't change the outlook of the US falling in a recession later this year or next year.

Some analysts oppose to the idea of a recession due to the fact that the labor market is still strong, but is important to take into account that the labor market is one of the most lagging economic indicators. While unemployment is an important recession indicator, unemployment usually peaks long after the recession has begun and can last well into recovery. That's because the NBER (and others) say a recession is over when the economic contraction hits bottom and starts to rebound, not when the recovery is complete. As an example, in 2008, the recession began in December 2007 and ended in June 2009, according to NBER. Yet in April 2008, five months into the recession, the U.S. unemployment rate was just 5%, up only slightly from 4.7% six months earlier. Unemployment continued to rise to hit 10% by October 2009, four months after the official end of the recession and seven months after the stock market hit bottom.

Is also important to mention that even though leading indicators can provide a picture of the direction we can expect the economy to take in the coming months, is not possible to derive from them the magnitude of the possible decline. At this moment, we could just consider that given that some of the numbers analyzed are in line with numbers seen in past recessions, historically it could mean that the probability of a serious contraction is higher than just a mild recession, but most importantly, given the FED narrative and actions to continue tightening while this economic contraction unfolds., which could lead them to an overtighten scenario.

According to the Sahm rule, the US economy will be in a recession when the unemployment rate hits 4.0%, the FED projections show an unemployment rate already of 4.6% in 2023 , a level above the rule threshold, and not in line when their narrative of a soft landing possible. The Sahm rule also shows that when the unemployment rate rises 0.5% over the course of a year, it ends up rising by around 2% or more, which means there is a probability the US economy could end up with levels of at least 6% unemployment.

6% Unemployment is in line with some analyst scenarios of 6-7% following the serious decline in housing activity the economy is experiencing, and even though is still a low level compared to other times in history, is the rate of change in the indicator that will determine how bad the recession will be, since the rate of change of the economy (GDP) will move according to the rate of change of the economic variables.