Housing sector enters yellow flag “recession watch” territory

 

 - by New Deal democrat

Residential construction permits and starts bounced back from their July Hurricane-Beryl affected decline, but housing units under construction declined below the threshold for hoisting a yellow “recession watch” flag for this sector. At the same time, I continue to suspect that we are rising from lows in the most leading metrics, and no “recession warning” is warranted.

To begin with, the most leading metric, housing permits (gold), rose by 69,000 to 1.475 million, the highest level since March. Single family permits (red), which are just as leading and have very little noise, rose 26,000 to 967,000, the highest since April. Housing starts (blue), which tend to lag permits by a month or two, and are much more noisy, rose 119,000 to 1.356 million, also the highest since April:

That’s the good news, and it is what I have been expecting, given the downturn in mortgage rates.

But units under construction is the measure of real economic activity in this sector. While it is not so leading as permits and starts, it has always turned down, typically by more than -10% before a recession begins (the average is -15.1% and the median is -13.4%).  Here is the long-term graph comparing total permits (blue, left scale) with housing units under construction (red, right scale):

And in August housing units under construction continued to decline, by another -29,000, to 1.509 million units, a decline of -11.8% from their 2022 peak. There is simply no valid reason to withhold raising the yellow flag at this point.

There had been a long time after single family construction turned down while multi-unit construction continued to increase and then plateaued. But this year both have declined:

So that is the bad news. But, mortgage rates red, left scale in the graph below) have been declining sharply in the past two months, and as of this morning are within .02% of their two year low of 6.09%:

And if the Fed cuts interest rates this afternoon, which seems almost certain, I expect a further decline. As a result, as I said one month ago, “we can expect permits to rise in the next several months, followed by starts,” for the simple reason that for 60+ years, mortgage rates have always led housing permits. Here is the YoY% change view of the past 10+ years (with mortgage rates inverted so that lower rates YoY show as above the 0 line), with which may be clearer:

This clearly suggests that permits are likely to turn higher YoY soon.

Last month I concluded: “That the most leading metric, single family permits, as well as mult-family permits, appear to be stabilizing, plus the likely effect of lower mortgage rates, plus the probable effect of Beryl on units under construction, together cause me to believe that raising the yellow caution flag for housing would be premature based on this month’s report. It’s very close, but I don’t think we’ve crossed the threshold yet, and there are still good reasons to believe we may not cross it at all.”

Well, contrary to my earlier belief, we have indeed crossed the threshold. But as shown in the second graph from the top above, the long historical view of housing units under construction and permits, with one exception (the tech producer-centered recession of 2001), in the case of recessions, permits continued to decline sharply even after housing units under construction crossed the -10% threshold and well after recessions had begun. In our present situation, if I am correct that permits have bottomed and are starting to increase again, then housing units under construction will not decline too much further before bottoming as well. 

In other words, although there are some increasing warning signs that I have written about recently, including with real retail sales just yesterday (and stay tuned for jobless claims tomorrow), my base case is that this period of weakness is likely to turn around without a recession occurring. That’s why at this point there is only a housing sector “recession watch,” meaning a heightened possibility, and not a “warning,” meaning one is more likely than not.

And now, some good news: industrial and manufacturing production rebounded strongly in August

 

 - by New Deal democrat

In the past, industrial production has been the King of Coincident Indicators, since its peaks and troughs tended to coincide almost exactly with the onset and endings of recessions. That weighting has faded somewhat since the accession of China to the world trading system in 1999 an the wholesale flight of US manufacturing to Asia, generating several false recession signals, most notably in 2015-16. But it is still an  important coincident measure in the economy. 

As with last month, there were significant downward revisions, but the story this month was a strong rebound.  Total production was reported higher by 0.8%, and manufacturing production by an even stronger 1.0% (graph normed to 100 as of pre-pandemic high water mark):

On a YoY basis, total production is unchanged, while manufacturing production has risen 0.2%:

In the above graph, I also show the updated YoY real retail sales YoY data (gold), which shows that both, in accord with their short leading status, real sales have anticipated the downward trend in production followed by two years of more or less treading water. 

Finally, here is the long term look at industrial and manufacturing production vs. real GDP (gold):

During the 20th century all the way up to the 1980s, when industrial and manufacturing production growth had declined to 0% YoY, the economy was entering or in a recession about twice as often as not. Thereafter right up until the pandemic while there was a marked deceleration in real GDP, a recession did not necessarily occur, most especially in 2015-16.

Here is the post-pandemic view:

With total and manufacturing production trending slightly higher in recent months (per the first graph above) compared with last year, this forecasts a steady real GDP somewhere in the neighborhood of 3% annualized this quarter.

The string of negative YoY real retail sales continues, confirming yellow flag

 

 - by New Deal democrat

One of my favorite bits of economic data, retail sales, did no better than treading water in August.

On a nominal basis, retail sales in August rose 0.1%, but after an upwardly revised blowout 1.3% in July. Which means, after adjusting for inflation, they declined -0.1%. The below graph norms both real retail sales (dark blue) and the similar measure of real personal consumption of goods (light blue) to 100 as of just before the pandemic:

Since the end of the pandemic stimulus in spring 2022, real retail sales have been trending generally flat to slightly declining, while real personal consumption expenditures on goods have continued to increase.

On a YoY basis, real retail sales continue to be negative, at -0.4%, which remains problematic as it has all this year:

That’s becuase, although I won’t bother with the graph, a negative YoY comparison in real retail sales over the past 75 years has usually meant recession. As I said last month, obviously that wasn’t the case in 2022 and 2023, but at some point the historical relationship is likely to be valid again.

Finally, since real sales are a good if noisy short leading indicator for employment, here is the above YoY graph adding YoY payroll gains (red):

This forecasts continued weak job reports in the range of 75,000 to 175,000 in the months immediately ahead.

Three months ago I wrote for the first time that real retail sales had to be regarded as raising a caution flag for the economy. Two months ago I amplifyied that to say “The yellow caution flag is up,” especially in conjunction with the negative ISM manufacturing and non-manufacturing numbers. And last month I concluded by saying that “the longer real retail sales go without posting a positive YoY number, the more concerned I will be.”

At the beginning of this month, the economically weighted ISM indexes came within a hair’s breadth of warranting a “recession watch.” This real retail sales report puts even a little more weight on the scale, and really puts the pressure on initial jobless claims, which have remained assiduously positive, but from this Thursday forward for the next half year will turn neutral or even negative to the extent they are above 220,000.

On the un-inversion of the 10 minus 2 year Treasury spread

 

 - by New Deal democrat

In the past couple of weeks, the spread between the 10 year and 2 year Treasury has normalized; that is to say, the interest rate on the 10 year once again is higher than the interest rate on the 2 year. A number of articles have claimed that this portends a recession in the next few months.

Not so fast! Says I. When you look at the entire history of that interest rate spread, and you consider other, similar Treasury interest rate spreads, a much more complex, even contradictory signal appears.

This article is over at Seeking Alpha. As usual, clicking over and reading will hopefully be enlightening as to the value of this economic indicator, and reward me a little bit for my analysis.