Long leading indicators embedded in Q2 GDP suggest a recession is near at hand

 

 - by New Deal democrat

Where does the economy go from here?  If it’s not in recession, it isn’t doing much better. There are two components of GDP which are helpful in finding out what lies ahead: real residential fixed investment (housing) and proprietors income (a proxy for business profits). Both of these have long and good track records as helping forecast the economy one year in advance. 

Let’s start with real residential fixed investment. As was indicated in the BEA’s accompanying graph this morning, it was one of the two worst sectors of the economy in the 2nd Quarter, down -3.7%:

Nominal and real residential fixed investment as a share of GDP (the actual measurement that is part of the long leading indicators) also both declined sharply:

Recessions have typically happened on average 7 quarters after the last peak in this measure, which took place in Q1 2021. This puts the most likely onset of a recession in Q4 of this year.

The news is much more equivocal when it comes to proprietors’ income.

Frequently both corporate profits and proprietors’ income turn together, but sometimes proprietors’ income lags by 1 or 2 Quarters. But the actual leading metric deflates for unit labor costs, which also aren’t known yet for Q2. So here is a bar diagram for the last 21 months of the Quarterly % change in corporate profits (blue), proprietors’ income (dark purple), and unit labor costs (red):

If unit labor costs rise in accord with their last 3 quarters, then proprietors’ income will still be slightly positive for the Quarter, but still below their peak in Q2 2021. In other words, our proxy for corporate profits indicates that a recession could begin at any time, since the last peak was 1 year ago.

In addition to the above two long leading components of GDP, real money supply for June was reported on Tuesday, and the news wasn’t good there, either.

Recessions have typically occurred one year or more after real M1 turns negative, or real M2 is up by less than 2.5% from one year previous. Here’s what they look like now:

Real M1 and M2 are consistent with an onset of recession next spring.

In short, the long leading indicators that were updated this week suggest that a recession, if not here now, is nevertheless likely near at hand.

Increasing trend in initial claims continues; on track to signal recession in November

 

 - by New Deal democrat

Initial jobless claims declined 5,000 to 256,000 last week. But hold your celebrations, because that was because last week’s 251,000 was revised 10,000 higher! The 4 week average rose another 6,250 to 249,250, a nearly 8 month high.  On the positive side, continuing claims declined 25,000 to 1,359,000:

Typically, but not always, initial claims have risen by 15% or more over its low before a recession has begun. And a longer term moving average of initial claims YoY has, with one exception, turned higher before a recession has begun.

There is now a clear uptrend in all three numbers. The 4 week average of initial claims is now 50% higher than its low. Further, at their present rate, claims will turn higher YoY in November, which would be the signal for an imminent recession.

Finally, because initial claims lead the unemployment rate, it is likely that there will be an uptick in that metric in next week’s jobs report for July.

First comments on Q2 GDP: no, we’re not in a recession (yet)

 

 - by New Deal democrat

When the negative print on Q1 GDP first came out three months ago, I wrote:

“yes, it was a negative GDP print. No, it doesn’t necessarily mean recession…. But the big culprits were non-core items. Personal consumption expenditures, even adjusted for inflation, were positive. The three big negatives were a big decline in exports vs. imports, followed in about equal measure by a decline in inventories and a downturn in defense production by the government.”

Lo and behold, the above is almost equally true about Q2 GDP! Here’s the helpful graph summary from the BEA in the official release:

I’ve also included the first bullet point explaining the inventory issue, which was the big negative in the report. Net exports minus imports wound up being a positive. Government spending was again negative, but this time was led by non-defense spending as, unsurprisingly, defense spending ramped up. The big negative addition was the big downturn in housing spending, about which I’ll have more to say later.

But I’ve made the point previously that the current expansion is very similar to the first two “Boom” expansions following the end of WW2. There was lots of inflation, but little change in interest rates. In fact, the Fed sat completely on the sidelines. It was when the “Bust” kicked in, as consumers were temporarily locked out of making durable purchases, that (shallow) recessions kicked in.

In fact, as Menzie Chinn wrote earlier this week, and Paul Krugman notes this morning, there were 2 consecutive quarters of negative real GDP in 1947, but no recession:

And Ben Casselman’s originating tweet points out that the negative and positive contributions to GDP at that time were very similar to the situation now:

My usual discussion of the long leading indicators in the GDP report will follow later.

Coronavirus dashboard for July 27: likely at or past the BA.4&5 peak

 

- by New Deal democrat

Let’s start with Biobot, since wastewater doesn’t lie. The bad news is, it shows a nearly 50% increase between June 29 and July 20. The good news is, in the last week of that period, between July 13 and July 20, it only increased less than 4%, suggesting that the BA.5/July 4 superspreader celebration wave has peaked, at a level equivalent to 500,000 “real” cases (from a starting point of 350,000):

The regional breakdown shows that the only region where wastewater has not plateaued is the Midwest:

Meanwhile, the CDC variant data indicates that by the end of last week, BA.4&5 constituted 95% of all cases:

This is consistent with infections from these variants being at or past peak. All regions of the country had similar variant profiles. There is no new variant (in particular, BA.2.75) making any appearance.

*Confirmed* cases (dotted line below) have remained between 120-130,000, with yesterday at 129,000. Deaths (solid line), at 429, have continued to plateau at roughly 100 more daily than in the April - June period (net the biweekly oscillations particularly in deaths are primarily an artifact of Florida’s reporting “system”):

Breaking down confirmed cases by Census region shows that only the Midwest shows a slight increase:

On the other hand, hospitalizations have continued to increase, to 46,700, consistent with evidence that BA.5 in particular is more virulent:

I think the BA.5 wavette has peaked, although whether we have a sustained plateau, or going into a substantial decline is completely unknown, but based on the experience of South Africa, which after the BA.4&5 wave declined to lows below even before the first wave of Omicron struck last November, I think the latter is more likely.

New home prices may have peaked after all

 

 - by New Deal democrat

Yesterday I wrote “The median price of a new home increased 1.7% in June (not seasonally adjusted), and remained sharply higher YoY at 15.1%.”

That’s true, but it wasn’t complete. The 15.1% figure is from the quarterly average. On a monthly basis, the YoY% change was 7.4%. Here are the monthly and quarterly figures together:

The monthly change is not seasonally adjusted, so my rule of thumb for peaks and troughs is that, when the rate of change is less than half the maximum YoY, the market has most likely turned. The biggest YoY% change in the past year was 24.2% last August, which means there has probably been a turn in the market.

But note that the monthly data, even YoY, is very noisy. For more confidence, we should at least average two months together. On that basis, the biggest YoY change was 23.7% for last July and August. This May and June together averaged 10.6%, so even on that basis it appears more likely than not that new home prices have peaked.

If so, this is the first of the four series (new home sales, existing home sales, the FHFA price index, and the Case Shiller price index) to have turned. 

New home sales continue to fall sharply, while prices for both new and existing homes continues to increase sharply

 

 - by New Deal democrat

New home sales declined further in June to 590,000 annualized and May was revised sharply lower as well:

This was the lowest number since the pandemic lockdown month of April 2020, and before that since December 2018. It is also over 40% lower than the peak reading of 1.036 sales annualized in August 2020. This is absolutely recessionary, as is easily seen in the above graph.

The median price of a new home increased 1.7% in June (not seasonally adjusted), and remained sharply higher YoY at 15.1%:

The FHFA and Case Shiller house price indexes were also released this morning. The also showed that house prices continued to increase sharply in May

The Case Shiller national index rose 1.0% for the month and 19.7% YoY, below last March’s 20.5%, which was the biggest YoY% gain ever. Meanwhile, the FHFA purchase only index rose 1.4% for the month, and 18.3 YoY, below its peaks of 19.3% in February, and 19.4% last July. The YoY% changes for both for the past 5 years are shown below:

While both are decelerating somewhat from their YoY peaks, they remain historically high.

Here is a longer term view, demonstrating that the current surge in house prices is the biggest in the past 30 years, surpassing even the housing bubble:

Owners’ Equivalent Rent (x2 for scale, black) is also shown above. As I have pointed out many times, OER follows house price indexes with roughly a 12-18 month lag. OER has also risen to a 30 year record YoY high, and can be expected to accelerate further for several more months at least.

We saw last week that the median price of an existing home sold in June also increased 13.4% YoY, indicating that sharp increases in those prices had not yet abated.

As I have frequently pointed out, sales lead prices. Prices can continue to rise for even a year after prices peak. But with this kind of sales decline, I fully expect outright price declines to follow, and soon.

Additionally, since OER plus rents contribute a full 1/3rd of the entire value of the CPI, and can be expected to accelerate further, I see very little reason to believe that, absent the Fed creating a recession, consumer inflation (outside of gas prices) is going to abate meaningfully anytime soon.

Book notes on Reconstruction

 

 - by New Deal democrat

No economic news of note today, and as usual insufficient Covid reporting over the weekend to make an update of that worthwhile, so let me dig out something from the back burner that I wanted to do for myself.

Last year I read Eric Foner’s 600+ page tome on Reconstruction, and this year read a treatment of “Lincoln and the Fight for Peace,” which described his final days and to the extent available his coalescing view of what Reconstruction should entail. I didn’t want to forget the main points, so I made a bullet-point synopsis:

1. John Wilkes Booth won. 

2. Why? Lincoln was replaced with Johnson, a loyalist Southern Democrat. Whereas Lincoln wanted to follow up the South’s complete surrender with a magnanimous peace for the masses, but to exclude the Confederacy’s leadership, and to require that the South accept the result of the war, Johnson’s intent was to restore Confederate States without restriction, i.e., to continue white supremacy, except with slavery technically outlawed. This poisoned the first several years of Reconstruction, until Congress wrested control.

3. The original sin of Reconstruction: no redistribution of all or at least some of Plantation land to the slaves whose uncompensated labor sustained it. Slaves were free but impoverished. Therefore no economic power.

4. Reconstructed Southern States went on a spending spree trying to attract railroads and other improvements. But in part because of the political fragility of Reconstruction, railroads and industry declined. Which created a vicious cycle, as it made Reconstruction even more fragile.

5. The North didn’t believe in racial equality either. Before the passage of the 15th Amendment, several Northern States defeated voting rights for Blacks, either Legislatively, or via failed ballot initiatives. As a general rule, the North wanted the racial issue settled, so they could move on.

6. In the final days of the lame duck period of his Presidency, Johnson issued pardons to all of the Confederate political and military leadership, enabling them to return to power, including both State and Federal elective office, which they subsequently did in droves - and also including 3 members of the Supreme Court that upheld segregation in Plessy vs. Ferguson. This was directly contrary to Lincoln’s plan, which would have specifically excluded them. In fact, Lincoln hoped Jefferson Davis would escape to South America, thereby depriving him of being either a martyr or a rallying point.

7. When white insurgency via the KKK and other insurgent groups started (many of them including those former Confederate military leaders), Reconstructed governments in the South were afraid to use military muscle, or to break “norms.” So white violence unpunished except in a few places where the Federal government stepped in.

8. On top of that, when the railroad investment bubble burst in the Panic of 1873, plunging the country into a deflationary recession, the North lost all remaining interest in expending energy on Southern Reconstruction. White insurgents pressed forward, toppling almost all of the Reconstructed Southern governments.

9. The contested Presidential election of 1876 was the final nail in the coffin of Reconstruction, as the Northern GOP traded the election of Rutherford B. Hayes to the Presidency in return for an end of Reconstruction in the South.

Had (at least large portions of) Plantation land been redistributed to the slaves who worked it, Freedmen would have had a base of economic power to hang on politically as well. They would have needed much less economic intervention and support from the Reconstructed State governments. 

It’s possible that the alacrity (between 1863 and 1869) with which freed Blacks were given full legal equality, but much more importantly, equal voting rights, was in large part responsible for the strength of the White backlash. In his final days, Lincoln seemed to favor a gradualist approach: immediate granting to voting rights to Black Union soldiers, plus those Blacks with property or education, with the remainder dealt with in some fashion later. *Maybe* had Black voting rights been phased in over a generation (with steps based on, e.g., education - as public schools, a priority for Freedmen, were one enduring legacy of the Reconstructed governments), with Federal protection in the interim, *perhaps* White fury would not have insisted in rolling back all of the progress made, and by 1900 Blacks would have been better off than they were under Jim Crow.

But the fact remains, the White backlash that reversed Reconstruction is a major example of a violent sustained insurgency that was successful, systematically rolling back rights that were explicitly guaranteed in the Constitution. That insurgency  remained successful for 80 years.

That opponents of the White violent insurgency now are making the same mistake of being afraid to violate “norms” in order to defeat it that the Southern Reconstruction governments made, makes me very pessimistic for the future of this country over the next few decades.

Weekly Indicators for July 18 - 22 at Seeking Alpha

 

 - by New Deal democrat

I wasn’t able to get to this link yesterday, but my Weekly Indicators post is up at Seeking Alpha.

The situation with the leading indicators continues to ever so slowly deteriorate. But there is some good news as well, as gas prices continued to decline precipitously from their peak.

As usual, clicking over and reading should be educational for you, and slightly remunerative to me.

Coronavirus dashboard for July 22: the BA.4&5 wavette has (probably) peaked

 

 - by New Deal democrat

No economic news today, so let’s update the COVID situation.

As of yesterday, nationwide (dotted line below) cases declined slightly to 123,000. Cases have been slightly elevated from their previous 100-110,000 range for several weeks, but appear to have peaked. Deaths (sold line) rose slightly to 429, and are roughly 100 above their average for the prior 3 months:

The above graph for the past year shows that the death rate per infection has steadily declined, particularly when you take into account the massive number of cases in the past 6 months where people rely on home testing and so the cases are never confirmed (probably around 2.5x the number of confirmed cases). Note that since the beginning of February almost 6 months ago, the US has weathered the BA.2, BA.2.12.1, and now BA.4&5 variants without a big (compared with original Omicron) increase in cases, and in general the case levels have been below even Delta at its peak. Nor did any of the new variants in the past 6 months substantially increase the number of daily deaths.

Cases in all four census regions of the US are either flat or declining (the West, thanks to California):

That isn’t just the case for the US. The below graphs by Trevor Bedford for various countries all norm deaths to infections at 1:1 for the initial 2020 wave. In all countries there are many multiples more infections for each death by now:

The situation isn’t quite so good as to hospitalizations, which have continued to rise in the US, to 45,200:

Dr. Eric Topol has highlighted a study out of Denmark that found worldwide higher hospital admissions due to BA.5, indicating it has more pathogenicity:

In the US, this may also reflect that most seniors have failed to get their second booster shot, so their protection has been fading even as the evidence has accumulated of the effectiveness of a second booster against this variant.

Speaking of variants, BA.4&5 constituted 91% of all new cases in the US by last Saturday, the remainder being almost all BA.2.12.1:

There was not much variation regionally:

Globally the BA.4&5 wave appears to have peaked in the large majority of big countries, and I suspect we are at or just past peak in the US (note: wastewater reporting has not been updated in the past 9 days, so it’s impossible to confirm with that data). In South Africa, where BA.4&5 first appeared, cases actually are currently *below* their pre-Omicron levels.

Finally, BA.2.75 continues to appear in more countries on an isolated basis, with no evidence of any waves outside India. If it proves to be a damp squid, the US could get another respite.

Increasing trend in jobless claims continues; on track to give recession warning in November

 

 - by New Deal democrat

Initial jobless claims rose another 7,000 to 251,000 last week, an 8 month high. The 4 week average rose 4,500 to 240,500, a 7+ month high.  And continuing claims also rose 51,000 to 1,384,000, which is 78,000 above their 50 year low set on May 21:

Three weeks ago I noted that, reviewing the entire 50+ year history of initial claims, “there are almost always one or two periods a year where the four week moving average of jobless claims rises between 5% and 10%. About once every other year for the past 50+ years, it rises over 10%. Typically (not always!) it has risen by 15% or more over its low before a recession has begun. And a longer term moving average of initial claims YoY has, with one exception, turned higher before a recession has begun.”

There is now a clear uptrend in all three numbers. The 4 week average of initial claims is about 40% higher than its low. If the present trend continues till about November, initial claims will be higher YoY, which would signal an imminent recession.

Just speculating here, but an entire very speculative sector of the stock market - internet based delivery services - which boomed during the time of pandemic restrictions, has blown up. I suspect many of the increased layoffs are coming from that sector.  Meanwhile more and more businesses are probably learning to make do with being short-staffed as the result of being unable to fill job openings. In any event, the rising trend in layoffs is very much intact. Because initial claims lead the unemployment rate, I fully expect to see an uptick in that rate in the next month or two.

Existing home sales now down 25% from peak; but price increases keep steamrolling on

 

 - by New Deal democrat

Although existing home sales are less economically important than new home sales, what has been happening with their prices, given the experience of the housing bubble and bust 15 years ago, is of added importance.

The simple summary is that sales have declined precipitously, while price appreciation keeps stubbornly rolling on due to (still!) a severe lack of normal inventory.

Sales of existing homes declined 4.4% for the month, seasonally adjusted; 9.4% YoY; and 25% from their October 2020 peak. At 5.12 million annualized, sales were at the lowest level since June 2020:

In fact, pulling back 5 years, excluding the pandemic lockdown months, sales were at their lowest since January 2019 (note graph does not show this morning’s data):

This is very much a level consistent with an oncoming recession.

The story is completely different as to prices. At $416,000, the median price of an existing home increased 2.1% for the month, and 13.4% YoY (Note: prices aren’t seasonally adjusted, so the YoY view is the best measure; graph does not show this morning’s data):

The peak in YoY growth in prices was May 2021, where prices increased 23.6% YoY. The low this year was April’s 10.4% YoY growth. Since my rule of thumb as to non-seasonally adjusted data is that a decline of 1/2 of peak YoY change is necessary for a real-time peak, we still are not at the point where prices are actually declining - although there are lots of anecdotal signs that we may be close.

The reason for this is in inventory. Last month I wrote that. “in May inventory was still down -4.1% YoY. Importantly, the NAR’s weekly update showed inventory increasing YoY in the last week of May and the first several weeks of June, so this may be the last hurrah for that metric.”

And indeed it was, as inventory in June was up 2.4% YoY:

A longer term look from the NAR’s new and active listing data, which goes back 6 years (note: seasonal peaks have typically occurred in May) shows that while *new* listings in June were higher than in any previous June except for 2019, active listings are still only about at 50% of their typical pre-pandemic levels:

New listings were up 100,000 YoY in June, but they need to increase to about +600,000 YoY to make up the total shortfall in active listings. Needless to say, we have quite a ways to go. 

So price increases have rolled on. So far.

Sharp downturn in June housing starts confirms earlier negative signals from permits, sales, and mortgage applications

 

 - by New Deal democrat

For the last few months, I have highlighted the record number of housing units that had permits, but had not yet been started, pointing out that it distorts the economic signal. Last month I closed with the statement:

“The conundrum is whether the 50 year high backlog in units not yet started will delay the downturn until it clears - which might take another 6 to 12 months. Since starts are the actual economic activity, until I see an unequivocal downturn there, the massive negative signal from permits, mortgage rates, and mortgage applications remains open to question.”

I would say that today we got the signal. Both permits for single family units and total starts turned down sharply. In the month of June single family permits declined -8.0% to a 2 year low - a little more than a 20% total decline from their January 2021 peak (red in the graph below); and starts declined -2.0%, tying their one year low at 14% below their peak in April of this year. Since monthly starts are noisy, the quarterly average is a much better signal, and in Q2 starts did decline -4.0% (blue). The quarterly average for single family permits (gold) also declined over -12.0% (gold):

In other words, with permits continuing to fall, and starts now also in decline, we have a verified leading signal.

What about housing under construction? To put that in perspective, the below graph shows housing data as it “moves through the belly of the beast;” including total permits (red), units permitted but not yet started (gold),starts (blue), units under construction (black), and housing completions (gray), for the past 3 years:

Both permits and starts have peaked. Further, it appears that units not yet started also peaked several months ago. Housing under construction appears to be peaking now. Completions still appear to be in a slight uptrend.

Housing under construction is the ultimate coincident marker of housing economic activity. Once that begins going down, housing’s contribution to the economy is negative in real time. We are probably only a month or two from that point. In other words, the leading indicators will be joined by the coincident indicator.

Not to be totally Doomish, let me show you the same information as in the first graph above, for the period of time when the 2000s housing boom turned into a bust:

In that case, permits were down about 33%, and starts down 25%, at the point when the Great Recession began. In other words, this downturn to date is only about half as bad as the one that presaged the Great Recession.

The final housing domino to fall will be prices. We’ll get a very important read on them tomorrow when existing home sales are published.

A note on inflation and whether the Fed should continue to raise rates - and whether it is “behind the curve”

 

 - by New Deal democrat

No important economic releases today, and almost no reporting by States as to COVID counts over the weekend, so let’s back up and take a look at something that’s been simmering on my intellectual back stove, so to speak: should the Fed be raising rates to combat this inflation? Has inflation already peaked? Or is the Fed way behind the curve and needs to raise rates a lot more?

Menzie Chinn has a guest post up, indicating that if the Fed had been following their own rules, they would have started raising rates during 2021. At the end of the day, I agree. Here’s why.

To begin with, I agree that if the sole sources of inflation are supply-based (the same amount of money chasing a shortfall in products), there’s no real point in raising rates. You can raise rates to 10% or 100%, if there’s a supply bottleneck, it’s not going to solve your problem; it’s just going to create lots of unemployment. In other words, for supply bottlenecks the best strategy is to leave high inflation alone, and don’t try to bring down employment.

But if inflation is demand based (more money chasing the same amount of goods as before), then raising rates to tamp down on demand makes sense.

Which one - or how much of each - do we have?

One good part of the answer is that inflation is global phenomenon, it’s not just limited to the US, as this chart helpfully put up by Kevin Drum shows:

If the source of inflation were US domestic stimulus, we wouldn’t see that type of global chart.

That suggests that, at least globally, the primary source of inflation is supply-based bottlenecks.

In the US, there have been 3 major sectors of inflation: energy (oil and gas), vehicles, and housing. Let’s look at them in order.

In the case of the price of gas, that did get tight by late last year, rising to $4/gallon over autumn and winter.  But the real spike took place at the end of February, when Russia invaded Ukraine, and sanctions were imposed:

This is a supply shortfall, caused by a geopolitical event. Per my note above, the Fed shouldn’t be raising rates because of gas prices.

Next is motor vehicles:

These spiked due to a computer chip shortfall sourced to Chinese and Taiwanese factories, in large part due to those governments’ “zero COVID” or strict lockdown policies. Again, this is a supply shortfall and raising rates is not going to cause either jurisdiction to make more computer chips (If I were Biden, I would have invoked the Defense Production Act long ago to substitute US-made chips during the COVID emergency, but that’s another issue)

Finally, here is housing:

Housing appears to have strong elements of both supply *and* demand at issue. On the supply side, existing homeowners more or less stopped putting their houses up for sale even before COVID hit, and definitely during the teeth of the pandemic:

Only now is increasing inventory coming on the market.

Further on the supply side, the price of lumber in particular skyrocketed:

This caused a huge backlog of houses under construction that were not completed:

But on the other hand, it’s also clear that extremely low interest rates, with record low monthly mortgage payments in “real” terms spike a surge in demand:

As night follows day, the record surge in house prices in 2021 and so far in 2022 has spilled over into rent increases and thereby in “owners’ equivalent rent,” the official CPI measure of housing inflation (we’ll come back to the black line, real GDP, later):

Housing is 33% of the entire CPI, and over 40% of core CPI.

So, is the main driver a shortfall in housing supply, or a surge in housing demand?

To look at that, I compared the growth in the total US population since the turn of the Millennium with the total amount of housing stock available in the US, which is helpfully estimated by the Census Bureau:

And the answer is, the available amount of housing stock has indeed kept up with population growth (by the way, this would be true even if I had measured from the worst possible comparison point just before the Great Recession). While there are certainly particular areas where that has not been true, and prices have been nuts for a long time (California!), the simple fact is that, averaged over the country, that is not the case.

In other words, housing inflation is primarily a demand, not a supply, issue, and since it is the single biggest slice of the CPI, that should have started to be addressed by the Fed once real GDP caught back up to its pre-pandemic levels, which according to the black line in the graph above was Q2 of 2021.

Had the Fed started raising rates then, it would have been attacking a CPI level of about 4%, and would have had a much better chance of obtaining a “soft landing” than it has now. In fact, the only way I see of the US avoiding recession at this point is if gas prices move all the way back down to the $4/gallon level, very soon, and stay there or below.