As the U.S. Goes, So Goes the Global Economy?

QMA’s recession dashboard indicates this record-long expansion still has legs.

October 11, 2019

Global growth has been anemic, but the U.S. economy has remained resilient. If the U.S. were to falter and slide into a recession, it would likely seal the deal on a global downturn, which is why the health of the U.S. expansion is of critical interest to investors worldwide.

With the inversion of the yield curve and the Institute of Supply Management’s manufacturing index dropping below 50 in both August and September (indicating contraction), recession fears have been amplified. Hence, we thought it was a good time to step back and assess the state of the U.S. business cycle using a tool QMA has used in the past: QMA’s U.S. recession dashboard. Here QMA considers four distinct indicators it believes are particularly useful for gauging the risk of a downturn: the slope of the yield curve, initial jobless claims, high yield spreads, and the Conference Board (CB) Leading Economic Index ®.
 

QMA's Recession Dashboard

QMA's Recession Dashboard

Risk Indicator

Signal

QMA's View

Yield Curve

The recent inversion of yield curve is a concern, but Fed policy is proactively easing, so QMA does not believe the inverted curve necessarily preordains recession.

Initial Jobless Claims

Initial jobless claims are the lowest on record with the number of job openings still exceeding the number of job seekers, which has pushed up wages 3% year over year.

High Yield Spreads

High yield spreads are historically low, signaling a low probability of corporate defaults.

CB Leading Economic Index

The CB Leading Economic Index is signaling a slowdown, but recent data in September exceeded forecasts for the first time since February, which argues in favor of a more benign view.

Source: QMA

 

Expansion     Caution     Recession

The Yield Curve

The recent inversion of the yield curve is admittedly a concern as yield curve inversions have preceded most recessions. Inversion suggests current Fed policy rate is too tight, and growth is too slow. However, historically, inversions have been caused by overzealous Fed tightening, choking off growth in response to an inflation threat. Furthermore, the current inversion is happening in the context of widespread negative-yielding bonds abroad, the unwinding of the Fed’s balance sheet, and strong demand for long Treasuries as pristine collateral for repurchase agreement (repo) trades.

Finally, unlike in the past, the Fed is proactively easing in response to anticipated weakness from global risks (i.e., the Fed is looking to get ahead of the curve). Therefore, QMA does not believe the inverted curve necessarily preordains recession. Even if the signal proves accurate in retrospect, the timing is usually tricky, as yield curve inversions precede recessions by at least a year on average. Typically, equities rise in the early stages of a yield curve inversion.

Source: Thomson Reuters Datastream as of 8/31/2019.

Initial Jobless Claims

Importantly, the other indicators on QMA’s dashboard are not confirming the alarming signal from the yield curve. Initial jobless claims are the lowest on record at 0.12% of the labor force. It may appear that the job market is cooling, with monthly payroll growth slowing to 130,000 a month, down from the more than 170,000 a month we’ve seen the prior 12 months. That said, the number of job openings still exceeds the number of job seekers, which has pushed up wages in excess of 3% year over year. The buoyant job market translates into a strong and confident U.S. consumer, whose spending powers 70% of the U.S. economy.

Source: Thomson Reuters Datastream as of 8/31/2019.

High Yield Spreads

High yield spreads, another component of the dashboard, remain historically low, suggesting the market is pricing a low probability of corporate defaults. While corporate debt in the U.S. is at very elevated levels, interest coverage, a measure of corporations’ ability to meet their interest payments, is in line with its norm, thanks to low rates. Moreover, as long as the Fed maintains easy monetary policy, debt repayment is likely to remain manageable.

Source: FactSet as of 8/31/2019.

CB Leading Economic Index

Lastly, many measures of the business cycle have been signaling a slowdown, and the Conference Board Leading Economic Index® is no exception. However, we have seen two other mid-cycle slowdowns during this long expansion, and this could simply be the third. The rebound in the U.S. Citi Economic Surprise Index, which measures whether data exceeds or falls short of forecasts, turned decisively positive in September after languishing in negative territory since February. This argues in favor of a more benign view.

Source: Thomson Reuters Datastream as of 7/31/2019.

All in all, the recession dashboard indicates that this record-long expansion still has legs, assuming, of course, that global risks don’t escalate in such a way that they push the U.S. past the point of no return.

For more details, read the full QMA Q4 2019 Outlook and Review PDF opens in a new window, which is available for financial professionals.


Footnote

The Bloomberg Barclays U.S. Corporate High Yield Index measures the market of U.S. dollar-denominated, non-investment-grade, fixed rate, taxable corporate bonds.

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