To watch for signs of an impending recession, I am grateful to New Deal democrat for his long leading indicator framework, which he adapted from Geoffrey Moore (see his post where he outlined his methodology here). This technique is designed to spot a recession a year in advance.
New Deal democrat monitors seven long leading indicators and his comments are shown in parenthesis after each indicator (click on links for the latest FRED charts):
- Real retail sales (It has peaked 1 year or more before the next recession about half of the time)
- Housing starts (Housing starts peaked at least one year before the next recession)
- Real private residential fixed investment (Aside from the 1981 “double-dip,” and 1948, it has always peaked at least one year before the next recession)
- Corporate bond yields (Corporate bond yields have always made their most recent low over 1 year before the onset of the next recession)
- Corporate profits and Proprietors` income, which can be a more timely proxy for corporate profits (Corporate profits have peaked at least one year before the next recession 8 of the last 11 times, one of the misses being the 1981 “double-dip.”)
Financial and monetary conditions
- Money supply (In addition to the 1981 “double dip,” on only 2 other occasions have these failed to turn negative at least 1 year before a recession)
- Yield curve, which may not be relevant in the current interest rate environment (The yield curve inverted more than one year before the next recession about half the time)
- Financial conditions, as measured by the Chicago Fed National Financial Condition Index and St. Louis Fed Financial Stress Index
New Deal democrat qualified the usefulness of these indicators in the following way:
Note that none of the indicators are perfect. None of them forecast the 1981 “double-dip,” which was engineered by the Volcker Fed. If the Fed similarly decided to raise rates aggressively in the next 6 – 9 months, or if there were an Oil price spike caused by a Middle eastern War, a recession could happen anyway.
In addition, I also use Georg Vrba’s work as another way of watching for possible recessions on the horizon:
Another real-time recession indicator was proposed by Fed economist Claudia Sahm. The “Sahm Rule” recession signal is based on a bottoming in the unemployment rate (FRED graph).
Other indicators of interest:
- New Deal democrat found that whenever the difference between the YoY change in the Fed Funds rate and Nonfarm Payroll rose above zero, a recession has invariably followed in about 12 months (FRED graph)
- Atlanta Fed’s GDPNow, the New York Fed’s GDP nowcast, and the St. Louis Fed’s nowcast of GDP growth
- US high yield (junk bond) spreads, corporate bond spreads, and Emerging Market bond spreads (FRED graph)
- Fed funds rate vs. Taylor Rule interest rate, assumes 2% inflation target and 2% real rate (for details see Building the ultimate market timing model, FRED graph)
- Temporary jobs, which is a leading indicator of employment trends, and a BLS researcher found that the quit/discharge ratio also seems to lead NFP (FRED graph)
- Initial jobless claims and S&P 500, which has shown a strong inverse relationship (FRED graph)