January 27 2023
A quieter week on the economic data front, with little out of the UK or the Euro area.In the latter there were numerous speeches made by ECB members which appear suggest that the central bank remains determined to continue raising rates to counter higher inflation. Christine Lagarde, the ECB president, was quoted as saying that “we will stay the course to ensure a timely return of inflation to our target.” Her colleagues have pointed to 0.5% hikes at the next two central bank meetings, with future decisions expected to be more data dependent. The fall in energy prices and higher than expected energy reserves, thanks to a warmer winter, may make the taming of inflation a little easier.
In the US, meanwhile, we saw the release of Q4 GDP figures, which showed that the economy grew by an annualised 2.9%, ahead of consensus forecast growth expectations of 2.6%. This did mark a slowdown from the previous quarter however, where a figure of 3.2% was recorded.
Whilst the beating of forecast is positive, it is very much a backward looking indicator. What investors and market observers are looking for are indicators as to whether we are going to have a recession or not and, if we were to, what would the severity of it be. The latter appears to be where the greatest guidance is sort. A number of leading indicators continue to suggest that a recession will be hard to avoid. The US Treasury 10 year – 2 year curve remains inverted, currently at a level not seen since the end of the 1970’s/beginning of the 1980’s. Whilst in no way a cause of an inflation, this measure has predicted previous US recessions with a high degree of accuracy.
Another leading indicator firmly pointing to a recession in the US is the Conference Board Top 10 Leading Indicator Index. Forming the index are financial and non-financial components, including:
- Leading credit index.
- S&P 500 index.
- Interest rate spread, 10 year Treasury minus the Fed Funds Rate.
- Average consumer expectations for business conditions
- ISM index of new orders.
- Building permits, private housing.
- Manufacturers new orders, non-defense goods ex. aircraft.
- Manufactures new orders, consumer goods and materials.
- Average weekly initial claims, unemployment insurance.This index has moved further into negative territory following widespread weakness among the indicators.
The index has a strong track record of anticipating recessions. There are a number of things however which it doesn’t provide. The first is an accurate time as to when a recession is declared. Lead times have previously varied from 3 months to 15 months, therefore make what you will of an average of 7-8 months. The degree or depth of the recession is also not clear from this.
It is the length and severity of the recession which is likely to determine the response of the Federal Reserve. For now they remain of the opinion that there will be no cut in interest rates this year, but that opinion might need to change in order to engineer a soft landing for the economy.
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