Recession Redux?: August 2011

With the economy weakening significantly over the last few months and the growing threat of an "double-dip" recession, let’s take a closer look at two particularly sensitive and typically accurate leading indicators of our economic health to see if we can tease out the future trends.



First, the Federal Reserve Bank of New York is known to use the yield curve (or more specifically the spread between the 10 year and the 3 month treasury yields) to calculate a probability of recession.



This method appears to have been spearheaded by Professor Arturo Estrella of the Rensselaer Polytechnic Institute and Professor Frederic Mishkin of the Columbia Business School as outlined in the June 1996 issue of Current Issues in Economic and Finance, a journal published by the Federal Reserve Bank of New York.



The yield curve probability method is said to have a nearly perfect track record at predicting recessions some two to six quarters ahead with only one false positive, a period in 1967 that many economists, most notably the late Milton Friedman, considered to have been a credit crunch/mini-recession even though the NBER does not officially recognize it as such.



Another important leading indicator with a solid track record is the Economic Cycle Research Institutes (ECRI) weekly leading indicator (WLI).



When the growth component of the WLI turns strongly negative (less then -6) it generally means a notable slowdown or recession is in the offing.



So what are these two important indicators saying about our current economic situation?



The yield curve spread indicator is indicating that the probability of recession is has climbed slightly to about 1% while the ECRI leading index is showing some weakening signs with the growth component declining to a slight negative value of -0.1.

It’s Beginning to Look a Lot Like Recession

Given today’s numerous bits of lousy economic data, I thought now might be as good a time as any to recap all the most recent data points that are beginning to tilt strongly in favor of recession.



First, housing seriously disappointed this year with sales remaining weak while prices clearly double-dipped making the government housing tax gimmicks of 2009 and 2010 look as ridiculous as “cash for clunkers”.



Although housing’s decline packs less of a negative punch to GDP (through declining residential investment) as it did during the worst years of the housing bust, its slow maturing unwind appears to be keeping homeowners under serious pressure thereby depressing consumption and leading to an overall loss of confidence as witnessed by the recent dramatic plunge to the University of Michigan’s Consumer Sentiment Index.



On that note, Real “Discretionary” Retail Sales looks terrible with consumers purchasing at a level first seen in 1993.



The Philadelphia Fed Business Outlook Survey, the Empire State Manufacturing Survey and the Richmond Fed Manufacturing Survey all are clearly singling contraction for regional manufacturing activity with the Philly Feds numbers plunging to a level that has historically been associated with the start of recession.



The latest installment of the Chicago Fed National Activity Index appears to be picking up this weakness with the 3-month moving average sitting ever so slightly above the level that the Fed considers to be the start (or continuation) of recession while the underlying index spent it’s third month in contraction territory.



The most recent GDP report dramatically revised the data for all quarters from 2007 on leaving the current estimate of real GDP significantly below the peak level seen prior to the Great Recession, a notable change in the perception of the “recovery” as well as the outlook going forward.



Finally, all of the above was, more or less, confirmed by the latest outlook issued by the Federal Reserve leading the FOMC to promise to hold rates at the zero bound for at least another two years, a clear sign that there is widespread agreement that the economy has weakened notably.

Existing Home Sales Report: July 2011

Today, the National Association of Realtors (NAR) released their Existing Home Sales Report for July showing continued weakness with slumping sales and an elevated monthly supply.



Single family home sales declined a notable 4.0% from June but rose notably compared to the level seen last year's post-tax scam weakness while the median selling price declined 4.5% below the level seen in July 2010.



Further, inventory of single family homes declined 5.4% from June and 8.6% below the level seen in July 2010 which, combined with the relatively slow pace of sales, resulted in an still elevated monthly supply of 8.9 months.



The following charts (click for full-screen dynamic version) shows national existing single family home sales, median home prices, inventory and months of supply since 2005.