Author: Kristina Hooper (Chief Global Market Strategist)
Last week, the US Treasury yield curve, specifically the spread between the 10-year US Treasury rate and the 2-year US Treasury rate, briefly inverted. An inverted yield curve is considered to be a good predictor of recession, and so markets sold off on fears that a recession will occur in the next year. However, I believe a US recession is not a foregone conclusion — and so we should monitor the economic data closely. I have received a number of questions from clients and the media about what other indicators to follow to help divine how the economy is doing. The following are just a few indicators to watch — and some caveats:
Four economic indicators to watch
The ‘wild card’ in the recession equation: Tariffs
While the above indicators can help provide a bigger picture of the state of the US economy, it’s critical to point out that, because of the escalating tariff wars, we are in unknown territory.
The strongest economies can become vulnerable to recession as a result of protectionist policies and trade wars. (For example, in 1929, before the Smoot-Hawley Tariff Act went into effect and before the Great Depression hit its peak, the US economy enjoyed 6% GDP growth and 3% unemployment.4) That’s because tariffs can have a number of negative effects, most significantly economic policy uncertainty.
Last week, the Reserve Bank of Australia (RBA) Deputy Governor Guy Debelle was emphatic in positing that the US-China trade dispute is causing significant damage worldwide because of the economic policy uncertainty it is creating. He explained the severity of the situation: “On the tariff side, the prospect of a 25% tariff is a first-order consideration in determining whether to invest in a new factory or new machinery and where to locate that investment. Businesses are waiting to see how the uncertainty resolves rather than invest. The longer businesses hold off, the weaker demand will be, which will further confirm the decision to wait. That runs the risk of a self-fulfilling downturn.”5
That’s why I also like to look at metrics that I believe can help determine the impact of tariff wars and economic policy uncertainty (some of which are components of the Leading Economic Indicators Index): CEO confidence, small business expenditure plans from NFIB (National Federation of Independent Business), and capital goods orders — all of which have shown weakness in recent months. The Economic Policy Uncertainty Index and the ISM Manufacturing New Orders Index are other metrics to follow in helping to ascertain the impact of economic policy uncertainty, and both are indicating a pickup in uncertainty.
Recession does not appear imminent
While these indicators have been on the decline and are clearly illustrating the impact of the ongoing tariff wars, none are signaling an imminent recession. And the US consumer remains strong, as evidenced by strong July retail sales, which rose 0.7% — far better than forecast.6 This is important given that the US economy is largely consumer-driven.
While the consumer is still strong currently, we have to pay attention to consumer sentiment, which is signaling a warning. Last week, we learned that overall US consumer sentiment fell to 92.1 in August, the lowest reading since the start of 2019.7 According to a statement from the University of Michigan, “Consumers strongly reacted to the proposed September increase in tariffs on Chinese imports.”
The good news is that, although the economy is slowing, central banks are being proactive. In just the last week, several central banks, including the Reserve Bank of India, cut key rates. While I am not confident that central bank accommodation can reverse damage created by tariffs, I am confident that central bank policies will help support risk assets even as the global economy decelerates. I could envision a scenario in which the economy decelerates, but stocks and other risk assets perform relatively well. I believe that investors with longer time horizons are likely to benefit from staying the course — remaining well diversified and exhibiting intestinal fortitude in the face of unnerving headlines.
1 Source: Institute for Supply Management
2 Source: Bureau of Economic Analysis
3 Source: The Conference Board
4 Sources: US Census Bureau; Louis Johnston and Samuel H. Williamson, "What Was the U.S. GDP Then?" Measuring Worth, 2019.
5 Source; Reuters, “Sino-U.S. trade dispute risks self-fulfilling downturn: RBA,” Aug. 14, 2019
6 Source: US Commerce Department
7 Source: The University of Michigan Consumer Sentiment Index.