Recession Prediction on the Clock

From the San Francisco Fed:

(Note that the jobless unemployment rate is defined as the fraction of people who are unemployed—adjusted for workers who lost jobs and are on temporary layoffs—in the labor force over time.)

This Economic Letter discusses how the jobless unemployment rate can be turned into a predictor for recessions. The resulting predictions are surprisingly accurate, on par with those derived from the more commonly used Treasury yield curve.

(…) The smoothed jobless unemployment rate bottomed out and turned before every recession except in 1982. Furthermore, the estimated historical trend never turned at any other part of the business cycle. (…)

Actual and smoothed jobless unemployment rate

Source: Bureau of Labor Statistics, FRED, and author’s calculations.

Figure 2 plots the change in the smoothed jobless unemployment rate (first derivative) on the horizontal axis and the change in the change (second derivative) on the vertical axis. Recession months are depicted as red dots and expansion months as green dots.

Clockwise movements of jobless unemployment rate

Source: Bureau of Labor Statistics, FRED, and author’s calculations.
Note: First derivative measures the change in the smoothed jobless rate; second derivative measures the change in the change of the smoothed jobless rate.

Charted this way, the time series shows the mostly clockwise movements around the origin where the zero lines cross. To describe the movement, I turn the chart into a “recession clock” using estimates of the historical cyclical trend. Turning points in the time series occur when the change is zero and increasing, that is, when the curve crosses 12 o’clock, moving from the second quadrant into the first quadrant, labeled in Roman numerals in the figure. Notably, recessions start a few months later, as indicated by a few expansion months (green dots) after the turning point moves into the first quadrant. (…)

Compared with the slope of the yield curve, the real-time recession probability based on the jobless unemployment rate is substantially less reliable at the 12-month horizon. The slope of the yield curve performs much better with this longer lead time.

At the six-month horizon, however, both the historical trends and real-time estimates based on the jobless unemployment rate outperform the slope of the yield curve (…).

Based on current data, recession probabilities are elevated according to the slope of the yield curve where they are 25 percentage points above the threshold for recession prediction at a 12-month horizon.

For the jobless unemployment rate, they currently stand 16 percentage points below the threshold at a 6-month horizon and are thus still relatively low. While the most recent reading of the recession clock has crossed 12 o’clock into the first quadrant, the three-month moving average still shows that it hasn’t done so on a sustained basis. This assessment could change quickly if the unemployment rate ticks up in coming months. (…)

Most forecasts of a recession in 2023 see it beginning in Q1 or Q2. The San Fran Fed’s clock suggests no recession before Q3, if any.

It so happened that yesterday we learned that

US Goods-Trade Deficit Narrows to Smallest in Nearly Two Years

The US merchandise-trade deficit narrowed in November to the smallest since December 2020 due to a plunge in imports.

The shortfall decreased 15.6% — the most since 2009 — to $83.3 billion last month, Commerce Department data showed Tuesday. The figures, which aren’t adjusted for inflation, compared with a median estimate for a gap of $96.3 billion in a Bloomberg survey of economists.

Imports retreated 7.6% to $252.2 billion, the lowest in more than a year. The value of exports declined 3.1% to $168.9 billion.

The decline in imports was broad based, led by a 13% drop in the value of consumer goods. Other inbound shipments of autos, food and beverages and industrial supplies also decreased, as did most export categories.

While imports of consumer merchandise have fallen from a record earlier this year, they remain well higher than the pre-pandemic average. (…)

The trade deficit, which widened to a record earlier this year, has been a drag on gross domestic product, largely due to a surge in imports.

The November data generate “some upside risk” to growth in the fourth quarter, according to JPMorgan Chase & Co. economist Daniel Silver.

“We still think that net exports will subtract from GDP growth in 4Q on average, but we now look for a more modest trade drag than we had previously been anticipating,” Silver said in a note. (…)

Goldman Sachs disagrees, boosting its “Q4 GDP tracking estimate by three tenths to +2.0% (qoq ar), reflecting sharply lower imports in November.”

The long awaited contraction in GDP seems to be pushed out again.

In yesterday’s Economic Perspectives, I argued that Americans’ splurge on durable goods mainly benefitted foreign manufacturers and that the U.S. inventory correction underway will thus mainly impact foreign manufacturers.

The sharp 7.6% drop in November goods imports is the first sign. The declines are broad: imports of consumer goods: -13.0%, autos: -8.9%, food: -7.6%, industrial supplies: -6.0%, and capital goods: -5.5%, all in nominal dollars.

This is happening while U.S. manufacturing production has stabilized at 3% above its pre-pandemic levels and new manufacturing orders hitting an all-time high in October.

Yesterday’s piece also notes that

U.S. manufacturing employment keeps rising and could actually grow in 2023 helping sustain related services employment (e.g. transportation, restaurants, banking). KKR says that “in 2022 U.S. companies have revealed plans to reshore nearly 350,000 jobs, compared to 110,000 in 2019.” That would boost manufacturing employment by 2.7% (+0.2% in total).

This chart illustrates how past jobs recessions are essentially due to manufacturing (red). Non-manufacturing employment (blue, 91.6% of all employment) generally only slows down without declining much on an annual basis:

If KKR is right on reshoring and employers keep hanging on to their scarce employees, this could well be a soft landing after all.

• Japan Industrial production fell as global demand weakened

Japan’s industrial production declined -0.1% month-on-month seasonally adjusted in November (vs -3.2% in October and -0.2% market consensus), recording a third consecutive monthly drop. In sequential terms, IP growth contracted to -1.4% 3Mo3M sa (vs 5.8% in September), meaning sluggish manufacturing activities will drag the current quarter’s GDP. 

Even worse news is that manufacturing output is likely to deteriorate in the first quarter of next year, given that IP is unlikely to rebound for the next few months. The sluggish exports in early December suggest a weak IP in December. China’s reopening will eventually boost Japan’s IP, but we think the positive effects will only be realized by the second quarter of 2023 or the second half of 2023.

Russia Bans Sales of Oil to Countries Imposing Price Cap The action follows moves by the Group of Seven nations barring Western companies from insuring, financing or shipping Russian crude at prices above $60 a barrel.

(…) The order says Mr. Putin can create exemptions for the sale of oil to countries following the price cap if he wants.

How the Kremlin views oil contracts—and how broadly it provides exemptions—will shape whether it creates a major disruption to global markets. Many of Russia’s crude exports are now selling at market prices well below the $60 cap, primarily to countries like India, China and Turkey that haven’t agreed to join the Western sanctions.

Some of these shipments are proceeding with the help of Western companies in line with the cap’s terms, according to people familiar with them, while others are happening with financing, shipping and insurance from outside the Western countries enforcing sanctions.

If the Kremlin decides to curb oil exports to non-Western buyers, it could reduce global supply and push up prices. If only the Western countries that crafted the price cap are targeted, the impact would be much more muted since they have already banned most Russian imports. (…)

Hungary and several other landlocked EU nations pushed for exemptions to the embargo to keep importing pipelined Russian oil. Mr. Putin may now shut off those flows. (…)

Russia has exported about 2.5 million barrels of its crude each day by sea in December so far, according to commodities-data firm Kpler. That is down 22% from the average for the first 11 months of the year.

That decline, largely reflecting reduced shipments from Russia’s eastern ports, is likely due to harsh winter weather and weak demand from China as its pandemic reopening has faltered, said Matt Smith, a Kpler oil analyst. (…)

Late last week, Russia’s mainstay Urals crude sold at $42.40 a barrel from the Baltic port of Primorsk, according to Argus Media, which tracks commodity prices. If the market price of Urals rises above $60 a barrel, the cap’s impact on markets could become more apparent.

Robert Yawger, executive director of energy futures at Mizuho in New York, said data indicate some buyers in Southeast Asia appear more reluctant now to snap up sanctioned barrels, leaving some tankers adrift in the Asia Pacific market.

“They’re looking for a home in India and China, but [those countries] have all the crude they need right now,” Mr. Yawger said. “They’re loaded up.” (…)

European countries, meanwhile, are preparing a February ban of refined petroleum products such as diesel that some analysts expect to have a greater impact on global markets. Western countries also will impose price caps on Russian petroleum products in February.

The energy conflict running in tandem with the war has contributed to “an unprecedented amount of uncertainty on the supply side and resulting volatility in oil markets,” said Paul Sheldon, a geopolitical risk analyst at S&P Global Commodity Insights.

Chip Inventories Swell as Consumers Buy Fewer Gadgets Semiconductor companies are slashing production plans to try to restore balance between supply and demand.

(…) Inventory levels, typically measured in days, are at their highest levels in more than a decade, or about 40 days above the median for the chip industry and its supply chain, according to a UBS analysis. (…)

Nvidia’s customers, the company said, are trying to burn through existing stocks before replenishing and buying the latest processors.

Inventory levels are expected to approach normal levels at the end of the company’s current quarter, which ends in January, Chief Financial Officer Colette Kress said in November.

Others put the turnaround later in the year. Micron said that it is expecting the situation to persist through the first half of its current fiscal year, which ends in September. Most customers are expected to have reduced their stocks to healthy amounts by the middle of 2023, Mr. Mehrotra said in a call with analysts. (…)

Industry executives expect chip sales to roughly double by 2030, surpassing $1 trillion globally. (…)

Laid Off Tech Workers Quickly Find New Jobs Most laid off workers in tech are finding jobs shortly after beginning their search, as employers continue to scoop up workers in a tight labor market.

About 79% of workers recently hired after a tech-company layoff or termination landed their new job within three months of starting their search, according to a ZipRecruiter survey of new hires. That was just below the 83% share of all laid-off workers who were re-employed in the same time frame.

Nearly four in 10 previously laid off tech workers found jobs less than a month after they began searching, ZipRecruiter found in the survey. (…)

Workers previously employed in other industries, including entertainment and leisure, transportation and delivery, and manufacturing, also found new jobs quickly, the ZipRecruiter data showed.

(…) tech firms making cuts are outnumbered by those that are hiring. (…) Client firms in tech also haven’t mentioned any plans to cut jobs, Mr. Sutton said. (…)

Related:

• Big tech continues trading poorly. Noteworthy is that Apple volatility has managed “beating” stuff like Google and Amazon volatility recently. After all, Apple has remained the relative king. What if this one gives in as well? (The Market Ear)

Refinitiv

Also related:

• Equity funds record largest ever weekly outflows -BofA

Investors shed stocks at the highest weekly rate ever in the week to Wednesday, selling a net $41.9 billion of equities, according to a report from BofA Global Research on Friday that attributed the sell-off to tax-related purposes.

U.S. value funds and passive equities also recorded record weekly net outflows, of $17.2 billion and $27.8 billion respectively, the bank said.

Investors also reduced their cash holdings by a net $59.5 billion, the biggest drop since February 2022, and sold the largest quantity of investment grade and high yield bonds in nine weeks.

Local emerging market bonds drew their first net inflow since April, while emerging market equities recorded a third week of inflows, adding a net $3.2 billion.

Bond funds recorded net outflows of $10 billion (…).

Remember that when money flows out of “funds”, these funds must sell (find buyers). Their largest holdings are often the big techs…

FYI:

• Computers vs Humans: Apparently computers got more AUM than humans… (maybe a debate to be had around semantics on this e.g. automatic rebalancing is designed by humans, even passive investing is essentially following the decisions of the humans at the index providers, and algo/quant traders are still the product of armies of PhD bearing humans). Intriguing development anyway, with most likely intriguing impact on market structure/function.

Source: @StatistaCharts (ChartStorm 19 September 2021)

Also related to the tech selloff:

• Instacart Cuts Internal Valuation by Another 20% to $10 Billion

Instacart, the grocery delivery startup that bankers expect will list its shares publicly next year, has cut its internal valuation to around $10 billion, according to two people familiar with the situation. The new valuation is 20% lower than the one it had in October and nearly 75% lower than the price investors paid for shares early last year, when its paper valuation was $39 billion. (…)

Chinese Demand for Travel Jumps as Beijing Opens the Floodgates

• China Covid Surge Leads Nations to Adopt Entry Restrictions

• The most commonly searched destinations included Hong Kong, Japan, Thailand and South Korea.
• Japan and India will require people arriving from China to show negative tests.

Russian foreign minister Sergey Lavrov told the state news agency Tass: “We keep warning our adversaries in the West about the dangers of their course to escalate the Ukrainian crisis. … [T]he risk that the situation could spin out of control remains high.” (AP)

FYI:

Visualizing EV Production in the U.S. by Brand

Data from the EPA’s 2022 Automotive Trends Report (for the 2021 model year).

Key Inflation Gauge Cools, US Consumer Spending Disappoints 

The personal consumption expenditures price index excluding food and energy, which Fed Chair Jerome Powell has stressed is a more accurate measure of where inflation is heading, rose 0.2% in November from a month earlier, Commerce Department data showed Friday. That matched estimates, but data for the prior month were revised higher.

From a year earlier, the gauge was up 4.7%, a step down from a 5% gain in October. The overall PCE price index increased 0.1% and was up 5.5% from a year ago, the lowest since October 2021 but still well above the central bank’s 2% goal.

Personal spending, adjusted for changes in prices, stalled in November, the weakest since July and below forecast. An increase in services spending, led by restaurants and accommodation, offset a decline in outlays on merchandise. New vehicles were the leading contributor of that decrease. (…)

The saving rate ticked up to 2.4% in November, the first increase since July but among the lowest readings on record, the Commerce Department report showed.

Inflation-adjusted outlays for merchandise dropped 0.6%, the worst since February, while spending on services rose 0.3%. (…)

Inflation-adjusted disposable income rose 0.3%. Wages and salaries, unadjusted for prices, were up 0.5% for a second month. (…)

The Fed must be pleased:

• Nominal wages and salaries are not slowing down, but, importantly, they are not accelerating per this particular measure (see below for other measures):

• Real wages are actually rising thanks to slowing inflation. Last 5 months, core PCE inflation averaged +0.2% per month and real disposable income is up 0.25% per month, more than 3% annualized.
• Goods are deflating, as expected: -0.2%/m since July and -0.4% in November.
• The particularly targeted durable goods are really deflating: -0.8% last month after -0.6% in October.
• Services prices rose 0.41% in October and 0.35% in November, still high but a welcomed stabilization below 5% annualized after reaching +7.3% a.r. in August/September.

November is the first month when the Fed’s drive to slow consumption and cool inflation shows convincing results. Real expenditures were flat in total and down 0.6% on goods (-1.5% on durables) while real services rose a steady, moderate 0.3%.

Core PCE inflation (blue bars) slowed from +0.55% in August, +0.46% in September, +0.26% in October to +0.17% in November.

Even PCE-Services prices (red) are behaving well.

Mr. Powell’s goal to see inflation slow over 12, 9, 6 and 3 months is currently met. Here’s the sequence: 4.6%, 4.3%, 4.3%, 3.6% respectively.

We’re not at 2% yet, but with the last 2 months at +2.6% a.r., the odds are very good that the sequence will be even lower by the time the FOMC meets next on Feb. 1.

In all, through November, the American consumer is slowing but not crashing. Actually, the Atlanta Fed’s nowcast of fourth-quarter real personal consumption expenditures growth increased from 3.4% to 3.6%. This with PCE inflation slowing across the board.

Real spending on durable goods has been flat in 2022, but not down as feared, holding well above pre-pandemic trends…

…critically sustaining retail sales, also slowing but still 15% above trend in nominal dollars:

The Atlanta Fed’s GDPNow model “estimate for real GDP growth (seasonally adjusted annual rate) in the fourth quarter of 2022 is 3.7 percent on December 23, up from 2.7 percent on December 20,” substantially above private forecasters’, with one month of data to go.

Americans are not losing their jobs, still see plenty of demand, enjoy wage increases of 5-6% (and large +8.7% cost-of-living adjustments on social security benefits impacting 70 million Americans) with inflation quickly receding below 4% thanks in part to a 38% drop in oil prices since June.

So far, the effects of the Fed’s aggressive tightening are limited to housing and an ongoing inventory correction, nowhere near what nasty recessions looked like. We seem to be in 1970, or 1990 or 2001, not in 1974, 1980-82 or 2008-09.

This next chart is pretty amazing, showing how industrial production (red) has uncharacteristically lagged durables consumption (black) and new orders (blue) since mid-2020. In previous recessions, inventories (green) declined well after new orders creating or aggravating the economic downturn.

This time, orders and inventories have flatlined at a high level, unusually standing 10-15% above production.

Meaning?

• Americans’ splurge on durable goods mainly benefitted foreign manufacturers. Goods imports surged 21.5% in 2021 and 18.7% in 2022 while domestic manufacturing production rose only 5.8% and 3.7% respectively.
• Supply chains issues are surely to blame for slow production and rising inventories. For instance, vehicle production has outpaced sales by about 15% since February 2020 but manufacturers’ inventories are down 78%, suggesting a lot of unfinished vehicles awaiting scarce parts.
• As supply issues ease in 2023, deliveries of vehicles will jump, potentially allowing production to rise after 5 years of no growth.
• The U.S. inventory correction will thus mainly impact foreign manufacturers.
• U.S. manufacturing employment keeps rising and could actually grow in 2023 helping sustain related services employment (e.g. transportation, restaurants, banking). KKR says that “in 2022 U.S. companies have revealed plans to reshore nearly 350,000 jobs, compared to 110,000 in 2019.” That would boost manufacturing employment by 2.7% (+0.2% in total).

This chart illustrates how past jobs recessions are essentially due to manufacturing (red). Non-manufacturing employment (blue, 91.6% of all employment) generally only slows down without declining much on an annual basis:

If KKR is right on reshoring and employers keep hanging on to their scarce employees, this could well be a soft landing after all.

That is unless a resilient job market amid a continued shortage of workers keeps pushing wages up, forcing the Fed to get even more hawkish. These trends in average hourly earnings are problematic:

Another possible scenario is that the inflation dragon appears defeated, cyclically, in 2023, bringing the doves out, only to realize later that it was not dead, structurally, and that the worst has yet to come…

While we wait for a clearer picture (!):

The Philadelphia Fed’s December surveys suggest that the soft landing scenario should be gaining weight:

• 53% of manufacturing firms and 48% of nonmanufacturing firms indicated that labor supply was a moderate or significant constraint on capacity utilization, down from 66% and 55% respectively in September. Easing across the board and faster in manufacturing.
• 45% of manufacturing firms and 41% of nonmanufacturing indicated that supply chain disruptions were a moderate or significant constraint on production, down from 68% and 43% respectively in September. Easing fast in manufacturing.
• 2.6% of manufacturing firms and 29% of nonmanufacturing firms (vs. 2.5% and in 16% respectively in September) said that access to financial capital was a moderate or significant constraint on capacity utilization. Worse and worsening faster for non-manufacturing.
• 26% and 63% of manufacturing and nonmanufacturing firms respectively expected access to capital to have a larger impact on capacity utilization over the next three months. Worse but worsening faster for non-manufacturing.

If the Philly Fed region is representative, the economic impact so far is much less pronounced on manufacturers, contrary to most expectations. Given that goods are already deflating, lesser pressures on wages at service providers could ease overall inflation faster than expected.

• Restaurant Staffers Are Returning to Work After Covid Flight Industry employment nears prepandemic levels as pay and working conditions improve.

(…) This past month, restaurants and bars had nearly doubled the number of employees working at the pandemic low in April 2020, according to the Labor Department. The past month alone, restaurants and bars added 62,000 jobs.

Restaurant owners and workers attribute the return to a combination of factors including pay increases, improving working conditions and fewer opportunities elsewhere as the economy weakens.

All but 2.1% of the 12.2 million food-service and drinking-establishment positions that existed in the U.S. in November 2019 had returned as of the past month, Labor Department data show. Restaurants, hotels and other leisure and hospitality employers have lagged behind the broader labor market, which in July added back the total number of jobs lost during the pandemic. (…)

Restaurant owners say applications have increased and more prospects are showing up for their interviews rather than ghosting operators, as many did earlier in the pandemic.

The share of job seekers interested in food-service and restaurant jobs is rising close to prepandemic levels, according to Jobcase, a job board specializing in hourly work. In October, 6.2% of individuals on the platform clicked on ads for food-service and restaurant jobs, compared with 6.4% in October 2019 and 5% in October 2021. (…)

Fast-food workers earned an average hourly wage of $15.17 in October, up 26% from before the pandemic, Labor Department data show. Wages for workers at sit-down restaurants rose 21% to $18.70 an hour. Both categories increased faster than the average worker’s wages; across private-sector employers, average hourly earnings for rank-and-file workers were up 16%.

Some restaurants have managed to staff up faster than others. Fast-food restaurants employed 4.6 million workers as of October, around 1% more positions than before the pandemic. Full-service jobs remain down 7.3% compared with February 2019. (…)

Retention has improved sharply since earlier this year, he said, with turnover dropping from 35% in the first six months of 2022 to 20% over the past three months. (…)

Restaurants’ margins, which have also been hit by rising costs for food, ingredients and materials, have declined to an average of 13% from 21% before the pandemic, according to a survey of 800 operators by market-research firm Datassential. Some restaurant operators said their margins are far lower than that. (…)

This is a highly unusual, complex cycle. The Fed could get its wishes reasonably fulfilled with a soft landing and decent inflation trends. But if wages don’t decelerate soon, the pivot may not happen and corporate profit margins could disappoint. Then the economy, and equity markets, could really suffer.

KKR, one of the best informed and savviest investor, is also highly uncertain of how monetary policy may evolve, offering rather unattractive risk-adjusted equity returns, particularly when compared with credit markets:

Our Forecasts Show a Wide Dispersion in the Path of Fed
Funds, Especially Over the Next 12 Months

(…) From a fundamental perspective, we expect margins to come under pressure as a sharp slowdown in nominal GDP growth is likely to coincide with sticky wage inflation and weaker labor productivity.

This backdrop, we believe, will limit how much companies can continually raise prices to offset elevated input cost pressures. Moreover, our Earnings Growth Lead Indicator (EGLI) suggests that earnings will be challenged in 2023.

In fact, our forecast for -10% earnings growth in 2023 is actually less aggressive than the model, given our view that the energy input might be overstated.

 

The current consensus for S&P 500 EPS growth is +4.9%.

Meanwhile, America’s main trading partner is already suffering:

Canada: GDP is running out of steam (NBF)

October’s growth came entirely from the public sector, with the business sector stagnating during the month.

Taking into account preliminary estimate for November, which indicates a moderate growth, quarterly growth is currently hovering around 1.0% in Q4, a clear moderation from previous quarters and well below potential growth of about 2.0%.

In a context of extremely restrictive monetary policy and consumers being struck simultaneously by loss of purchasing power, an interest-payment shock, and an unprecedented negative wealth effect, we continue to expect near stagnation in the first half of 2023.