Ear to the Ground

May 19 2023

Economic data has been thinner on the ground over the last week.  That which we have seen, however, appears to suggest that a US recession remains on the horizon.  The US Conference Board Leading Economic Index declined for the thirteenth consecutive month in April.  A level as low as the current one we are seeing has historically coincided with a recession.  The Conference Board forecasts a contraction in economic activity starting in the second quarter of this year, leading to a mild recession by mid-2023.

There continued to be weakness amongst most of the underlying components of this index.  There were only two positive components for the month of April, being the S&P 500 and Manufacturers New Orders (non-defense capital goods exc. aircraft).  The remaining components were negative, in particular Average Consumer Expectations for Business Conditions and ISM New Orders.  The probability of a US recession meanwhile, as predicted between the spread between the US 10 year Treasury and 3 month Treasury bill yield suggests an over 68% chance of a recession in the next 12 months, as at the 4th May.

This week also saw the release of the US Philadelphia Fed Manufacturing Index.  Pleasingly this improved to a reading of -10.4 from -31.3 in April.  This was better than the forecast level of -19.8.  Although still in negative territory, there were improvements for the new orders and shipments elements.  This potentially creates a little respite, with history showing that periods where this index has been south of -20 have been associated with a recession.  Over 37% of the firms which form part of this index however are still expecting a fall in activity over the next 6 months.

Meanwhile, US banks continue to tighten their lending standards when it comes to commercial and industrial loans.  Research shows that we are quickly approaching a level which was seen in previous recessions in 1990-91, 2001, 2008-09 and 2020.  I guess what this doesn’t show is to what extent conditions are being tightened, but what we do know is that base rates have come a very long way in a short space of time.

If we were to get a recession however I don’t think it would come as much of a surprise.  You could indeed argue that this has been one of the most predicted and telegraphed recession that we have seen in some time.  Furthermore, history shows that over the last six previous US recessions it has taken, on average, over 7 months for the National Bureau of Economic Research to call that a recession has started.

It is perhaps more pertinent, therefore, to be paying closer attention to what type of recession we may get, a soft or a hard landing, a normal run of the mill economic slowdown or one accompanied by some sort of crisis.  Perhaps only then will we know what the implications for asset classes will be.  But we will only know that after the event!  Known unknowns, unknown unknowns, some things never change in this game.

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