Friday, 27 July 2012

Tracking the recovery (2) - USA

Business cycle tracking continues with a half-year update but this time under a new title: 'Recovery tracking'. In the first version, published back in February (the latest data for January or December), the recovery didn’t look too good, but there were signs that things could have been better. After seeing confidence being lifted in February and March, things went back to their gloomy reality in May and June. 

Back then, I also presented an overview of business cycle indicators and valuable sources useful to familiarizing oneself with the business cycle theory. I advise the current readers to take a look, simply to get a better idea of the difference between leading, coincident and lagging indicators, and why and where economists use them. The indicators I observe here aren’t necessarily the best ones, but they do have a certain reputation for precision and robustness. 

As was the case last time, I start with the United States (for which there is a wide range of data available) while the next two posts will be concerning Europe and business and consumer confidence.

United States

Recent growth figures for the US (published today) show a slowdown of growth to 1.5% for the Q2 of 2012. The recovery has slowed down globally which is most likely due to the recent news from Europe (Greek and French election, Spanish bank bailout etc.). All this certainly affected the US, which is showing in the recent performance of its leading indicators. 

New housing building permits (a good leading indicator, as it provides insight into upcoming activities in housing construction and economic activity - induced in LEI)

Source: St.Louis Fed, FRED database
Compared to 6 months ago this indicator has been showing some signs of recovery, even though it's still on rather low levels (even when compared to all other busts experienced so far). However, the US housing market has experienced an unprecedented slump so it will take a lot of time for this indicator to recover. 

New orders in manufacturing: New orders in durable goods (maybe not so precise as a leading indicator for recessions, but may signal a potential recovery, although the indicator can be biased due to volatility in the transportation sector or defence, which can drive monthly figures unexpectedly) - depicted in the upper left on the figure below: 

Source: St.Louis Fed, FRED database
An increasing number (at least in the trend) of orders in manufacturing in durable goods is a positive sign for the recovery; however, when looking at the index of new orders (upper right), the picture is bleak at most. It seems this indicator has gone down in recent months signalling a potential decrease of confidence among businesses. 6 months ago the situation was a bit better, but even then the verdict was inconclusive. It is obvious that this indicator is highly sensitive to worrying signs of investor confidence that will constrain businesses in their expansion and new orders. Observing hours of production in manufacturing (lower left) can be tricky (the UK is a good example), while the index of supplier deliveries (lower right) is obviously on a decreasing trend, which goes hand in hand with the index of new orders, and paints a worrying picture of the US recovery. 

Fixed domestic investment (a powerful leading indicator that can drive aggregate demand; it falls faster during a recession and grows faster during a recovery than the GDP) - depicted in the upper left corner of the figure:
Source: St.Louis Fed, FRED database
It consists of non-residential (lower right) and residential fixed investment (lower left), where residential is still low (for the same reasons as the new housing permits indicator, which is what residential investment mostly comprises of). Within the category of investment, the best thing to look at is the inventories index (upper right) which is showing volatile movement in the past few years. While this indicator was the main reason behind good US GDP growth data back in January (when it stood at 3%), now it's one of the main drivers of the slowdown in GDP growth. Back then it was hard to tell whether the obviously temporary increase in inventories was due to higher expected future demand, or pilling up stock due to an overestimated demand. It turns out that the later was the case. 

Employment - population ratio: Last time I used a proper leading indicator - unemployment insurance claims - however, the increasing trend of people leaving the labour force made me use a much more precise  and unbiased indicator

Source: St.Louis Fed, FRED database
According to this one, there is still no sign of a recovery in the US labour market. Greg Mankiw likes to pull out this indicator in his regular posts on "Monitoring the So-Called Recovery". 

Finally, here is a joint, weighted-averaged US Leading economic index (LEI).

Source: St.Louis Fed, FRED database
6 months ago, the LEI was averaging higher while showing a slight move towards a negative direction. Now it has clearly gone downwards, implying a negative outlook in the next couple of months. It is possible that negative stock market signals (one of the indicators included in the LEI), worsening of new manufacturing orders, relative stagnation in building permits and residential investments, are all putting downward pressure on the LEI at this point. 

Verdict: Not good, and it's getting worse. And all the forthcoming uncertainty around the Presidential election by the end of this year (and of course around Europe) certainly won't help the economy. However, 2012 was even before it started announced to be a bad year for the global economy. I guess, half way into the year, we're just following that path. Even though the first quarter was looking better than what was being predicted at the time. Let's just hope that going into the summer, the August and September of 2012 don't turn out to be like August and September of 2011. 

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