AFMC - A Check On The 'Economic Screws'

Summary

• We check a number of "economic screws" that help hold the economy together.
• On balance, the economic screws are tight enough.
• If Treasury net-transfers are maintained, a recession in the next 6 months is unlikely.
• The only serious threat to the economy (and the stock market) in the next 6 months is the politics around the insane 'debt-ceiling' hostage-taking that is happening in Congress.

In our August 2022 article ( here ) that checked on the economic screws, we stated that there would not be a recession in the six-month period that was to follow. Just as we calculated, no recession appeared. In this article, we report on the current state of the economic screws that hold the economy together.

The Screws Holding the Economy Together

The first chart below is the BaR grid (from econpi.com) for Jan. 13, 2023, and the second chart is the most recent chart dated Feb. 17, 2023.

Notice that both the LD (leading indicators) and MoC (mean of coordinates) have moved back into the expansion quadrant . This means that the average of economic measures are, once again, starting to show economic growth. This screw is no longer loose, and progressively getting tighter.

The GDPNow estimate of Q1 2023 is above 2% and rising. This screw is 'tight enough' (chart below).

Industrial Production of the United States increased 0.8% y-o-y in January of 2023, the smallest annual gain since January, the smallest increase since the pandemic recovery started in 2021. Although the rate of increase is lower, industrial production does continue to increase. This screw remains tight enough, but just barely (chart below).

Capacity utilization either stalls or drops ahead of recessions. However, it is necessary, but not sufficient for a recession; no recessions resulted following the drop in capacity utilization of 1985, 1995, and 2015. This screw is loosening, but still considered tight enough.

PCE (personal consumption expense) , which is the Fed's preferred gauge of inflation, is up slightly in January, but still close to the lowest level since September 2021. This screw is in the process of tightening (chart below).

The University of Michigan consumer sentiment for the US was revised higher to 67 in February of 2023, the highest since January 2022. This screw is tightening.

The Aruoba-Diebold-Scotti business conditions index is designed to track real business conditions at high frequency. The average value of the ADS index is zero. Bigger positive values indicate progressively better-than-average conditions, and bigger negative values indicate progressively worse than average conditions. The index shows that business conditions have improved and are above average which makes it a tight economic screw (chart below).

S&P Global Manufacturing PMI for the US increased to 47.8 in February of 2023 from 46.9 in January. Although this was the third month of increases, the index is still in a protracted fall from mid-2021 levels and is below pre-COVID levels. This screw is loose.

Banks tightening lending-standards always precedes recessions, but tightening lending-standards does not always lead to recessions; e.g. 1994-1999 and 2014-2016. What is clear, is that lending standards are raised when the FFR is raised, but recessions happen only if rates get too high for the economy to cope. At the moment, it is unknown if the Fed will go too far, which means this screw is loose.

However, recessions occur when both lending-standards and delinquency-rates are rising. At the moment, delinquency-rates are at low levels and not rising (green highlight below). This screw is tight.

Recessions are always preceded by at least one-year of falling housing starts . Housing starts have been falling for 10-months. This screw is loose.

Truck transport employment stops growing or declines (red highlights below) and heavy truck sales collapse (black highlights below) for more than a year ahead of recessions. Truck transport employment is growing and truck sales, while recently weak, have not collapsed (green highlights below). This is a tight economic screw.

The BofA High Yield Spread Index rises as economic conditions worsen, but not every rise results in a recession. Currently, the High Yield Spread Index is signalling an economic recovery (green highlight below). This is a tight screw.

Recessions typically materialize between 6-18 months following the second 10y-2y rate inversion , and after unemployment starts to rise. The chart below highlights how the 10y-2y is still in its first inversion and unemployment remains low and unchanged. The 10y-2y has to first rise, then re-invert, and unemployment has to rise dramatically before a recession (demand destruction) takes hold. These two economic screws are tight.

The fiscal response to COVID produced a post-WWII record government budget-deficit (private-sector surplus) which prevented a depression. The net-transfer (spending minus taxation) to the private-sector was +$2,908B in fiscal 2021. But in April and June of 2022, taxes drained ~$400B and ~$125B, respectively, from the private sector, and a return to pre-COVID spending levels produced a net-transfer of only +$1,166B ; a nearly- 2/3 reduction in private-sector surpluses which caused economic and stock market weakness in Fiscal 2022 (Treasury fiscal year-end is September 30).

In the first four-and-a-half months of fiscal 2023 (which started October 1, 2022) the net-transfer has been +$720B which extrapolates to +$2,000B annually; a 60% increase over 2022 . The positive effect of this increase to the private-sector surplus can be seen in the following two charts:

Our liquidity model clearly shows the effect of the increased net-transfers on the liquidity and the stock market.

The SPX is rising at the +$2T net-transfer rate (green line below).

As long as the Treasury maintains the positive net-transfers (budget surpluses), the fund-flow screw is tight and a recession and a bear market can be prevented. The only serious threat to the economy (and the stock market) in the next 6-months is the politics around the insane 'debt-ceiling' hostage-taking that is happening in Congress. If in order to raise the debt-ceiling the Democrats agree to spending cuts and "balancing of the budget", then a recession is almost guaranteed before the fiscal year is out.

In conclusion, the balance of "economic screws" are tight and a recession in the next 6-months is unlikely.

For further details see: