A Framework That Provides Clarity

During periods of “low visibility,” confusion reigns: for every indication of one trend, there seems to be a countertrend. The key is to glean from the collective wisdom of reliable leading indicators a clear signal that the economy is headed for a turn.



Credit Markets Signal Recession in Early 2019

Surging borrowing costs for companies in the United States and Europe threaten recession within months and resemble events leading up to the global credit ‘heart attack’ in August 2007.

Risk spreads on American high-yield debt have jumped 130 basis points to 446 since early October. The weakest CCC junk grades have jumped 280 points to 1,233.

Credit experts say this sudden stress is the delayed fall-out from months of double-barreled monetary tightening by the US Federal Reserve.

The Fed is not just raising interest rates rises. It is at the same time shrinking its balance sheet by $50bn a month, perhaps draining more liquidity from global financial markets than it intended.

Simon Ward from Janus Henderson said his leading indicator for the health of US companies - real non-financial business M1 - has turned deeply negative for the first time since the Lehman crisis. This points to a sharp slowdown next year. “When this measure of cash contracts it means companies plan to cut back,” he said.

Mr Ward said the Fed risks a policy error if it presses ahead with further rate rises this week, or gives hawkish guidance for the future. “They have already gone too far. That is the clear implication of this monetary contraction,” he said.

Lakshman Achuthan from the Economic Cycle Research Institute (ECRI) in New York said a ‘stealth slowdown’ has been underway for much of this year, though this was disguised by the adrenaline rush from Donald Trump’s fiscal stimulus. “There is no bottom in sight. Our leading indicators are still decelerating,” he said.

House prices have been falling since April. The NAHB housing market index dropped to 56 this month from from 60 in November and 68 in October. The indicator for New England and North East plunged to 37.

“I think Fed policy is too tight given that inflation peaked in July. They overstayed their welcome,” said Mr Achuthan.

What is not clear is whether this is another mini-cycle of rising and ebbing growth - the fourth in a decade - or the start of deeper trouble.

“We are not yet willing to call a recession until the slowdown is ‘pronounced, pervasive, and persistent’. We don’t have that yet,” he said.

Mr Achuthan said Europe is a bigger worry. The slightest external shock will push Italy over the edge at this point.

“Italy is the worst of the lot but even Germany and France in the core are vulnerable. They look just as wobbly as the UK, frankly,” he said.

ECRI said the European Central Bank may have made a serious mistake by shutting down quantitative easing into the teeth of a worldwide cyclical slowdown.

The IFO index of business expectations for Germany fell below the boom-bust line to 97.3 in December, a four-year low. Manufacturing and export orders are near contraction levels.


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