Leading economic evidence continues to teeter at levels that have always and only been breached in recessions, but the sharp deterioration we initially observed late last year has been followed by modest stabilization - though still near the area that has historically marked the entry to economic contraction. The uncertain outcome and the incomplete view evoke a line from Leon Russell - "I'm up on a tightwire, one side's ice and one is fire... but the top hat on my head is all you see."
We can respond to the easing of downward momentum in several ways. We could pound the table about recession risk, based on the fact that previous breakdowns of the same magnitude in leading indicators have always resulted in recessions. Alternatively, we could emphasize the more favorable recent data and abandon our concern about recession, particularly because of the significant decline in new unemployment claims (though there is a great deal of seasonal impact here, and new claims also tend to be lagging indicators by about 3-6 months - see Leading Indicators and the Risk of a Blindside Recession). The problem with both of these responses is that, in our view, each would overstate the case, and grasp at interpretations that are not supported by the data.
The interpretation best supported by the data is that recession risk remains very high based on the leading evidence and the typical outcomes that have resulted, but that the rate of deterioration has eased significantly, and it is simply unclear whether this is a temporary pause or a reversal. Rather than overstating the case one way or another, we remain strongly concerned about recession risk, but recognize the recent stabilization and the potential for a low-level continuation of that. On the indicator front, the economic data over the coming week could be informative (especially the introduction of the Conference Board's revised LEI, the Chicago Fed National Activity Index, and unemployment claims), but if the new data also muddles around near the flat-line, it will essentially reinforce the overall view that the global economy is close to slipping into recession, but is at least temporarily stabilizing.
Importantly, the recession risk we're observing is evidenced in a wide variety of indicators, various sets which we've reviewed in a number of recent weekly comments (see Dwelling In Uncertainty). For example, the chart below shows three widely-followed leading indicators: the OECD (Organization for Economic Cooperation and Development) Leading Economic Indicator for the total world, the OECD LEI for the U.S., and the ECRI (Economic Cycle Research Institute) Weekly Leading Index growth rate. All are presented in standardized form - zero mean, unit variance. The blue shaded areas are actual U.S. recessions. The yellow brackets depict what we call a "discriminator" - a variable that strongly discriminates between two groups of data, in this case recessions versus expansions. This particular variable shows the points in history when all three of those leading indices were below -0.5 (based on standardized values), and the average of the three was less than -1.0. Recessions have always produced this condition, and this condition has only been associated with recessions. Notably, this discriminator is active at present.
Despite the record of this and other indicators, we have to suspend the inclination to view recession as a certainty. It's still possible that this instance is different, and that the modest stabilization we've seen in recent economic data will be sustained enough to avoid a recessionary outcome. But in my view, the downside risk is high, and it entirely strains the evidence to say that we can discard recession concerns on the basis of the more comfortable data points we've seen in recent weeks.
Getting In Is Easier than Getting Out
My impression is that the recent stabilization is owed to a large extent to various central bank actions, primarily by the European Central Bank (ECB), that eased immediate liquidity pressures from the banking system late last year. Though many observers seem to be under the impression that the ECB has not yet "stepped in," this is really only true in the sense that the ECB has limited its direct purchases of distressed European debt. More broadly, the ECB now has a larger balance sheet - relative to European GDP - than the Federal Reserve has relative to US GDP.
