Economic Indicators Show Recession As Early As Next Month

Will more stimulus make a difference? 

Over the course of the last few weeks we have seen economic reports released that have raised recessionary alarm bells. In addition, the European drama erupted again as European bond vigilantes attacked Europe’s weakest links (PIIGS) and now the carnage is spreading to core European countries like Italy and France. In kind, global stock markets have sold off to the point where more than half of global stock markets have experienced bear markets. As to be expected, global central bankers are responding and taking action. The big question all are asking now is, will their actions be enough to turn the global economic slowdown around or will more economic and financial market damage need to be done before central bankers act more forcefully?


Back in June I made the case that past monetary actions from global central bankers were finally being felt in global economies (“Global monetary tightening taking its toll, risks mount”). The monetary tightening programs of central bankers globally that began in late 2009 and carried over into 2011 were designed to bring down inflation and overheated economies. The risk with every monetary tightening mode is that central bankers go too far and drag their economies into a recession which is often associated with some type of financial crisis. This phenomenon is made clear in the following figure of past U.S. Fed tightening cycles and associated financial crises.

The collective result of global monetary tightening over the past year has been a marked deceleration in global growth, and now it appears their actions have gone too far as leading economic indicators have not only decelerated but have dropped into negative territory. Shown below is the composite leading economic indicator (LEI) for the 34 countries of the OECD. The growth rate for the LEI has now turned negative after being positive for the first time since October 2007. Looking back over the last decade, the only false signal in the OECD LEI that didn’t lead to a recession here in the U.S. was in 2003, though that signal came after a prolonged bear market and sluggish economy. However, the current reading is coming after a strong bull market in equities and thus carries far more significance. I do not expect we are seeing a false signal.

Today we were treated to the August reading for the University of Michigan Consumer Sentiment report which showed a reading of 54.9, the third worst reading in history and well below the median estimate of 62.0. This has been the case now for the past month in which economists have been way off the mark in terms of their estimates and reality. This often occurs at major tipping points (both bearish and bullish) as economists often extrapolate past results into the future and thus overshoot at economic peaks and undershoot at economic troughs. The string of overshoots in estimates from the ISM Manufacturing Index to GDP to consumer sentiment indicates we are yet at another economic inflection point in which the economy is rolling over. What is troubling about the Michigan Consumer Sentiment reading is that it often leads turns in consumption trends. First consumer’s moods change and then spending patterns follow suit. The sharp drop in consumer sentiment suggests consumers are likely to pullback sharply on spending in the months ahead.

Lakshman – “You always have a slowdown before a recession. When that slowdown occurs there is a window of opportunity for growth to resume. When you have a shock during that window of vulnerability, it’s very risky business.”

Given the likelihood of a continued global slowdown in economic growth to persist into the end of the year, it appears then that whether we avoid a recession hinges on whether global central banks can take enough decisive action to overwhelm any shocks during what Lakshman calls this “window of vulnerability.” So far central bankers have taken initial steps to help calm global markets which appears to be working. Will it be enough? Not likely given leading economic indicators suggests further erosion ahead. Thus, unless central bankers open the monetary spigots even further we will be slipping into a recession into year end. It then appears there will be a tug-of-war between global economic prospects and the world’s central banks. Below is likely to be the formula that we will see at least into year end.

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