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  • Writer's pictureByron Gangnes

Leading Indicators Leading Where?

Updated: Jul 26, 2023

The leading Economic Indicators® (LEI) index from The Conference Board fell for the fourteenth straight month in May. A fall of this extent and magnitude has almost always been followed by a recession within the next twelve months. Could it be wrong this time around?

The LEI is a composite index that reflects movements in ten underlying indicators. Over recent months, the biggest negative contributions have come from two forward-looking indicators of spending, consumer expectations of future business conditions and the index of new business orders from the Institute for Supply Management's® Report on Business®. These suggest possible weakness in future consumer and business spending. Financial market variables are also pointing to contracting activity ahead. The Leading Credit Index™, which summarizes several measures of borrowing costs and availability, has worsened, and the difference (spread) between yields on ten-year and two-year bonds, is sharply "inverted," a sign that expectations of future growth are low and current borrowing costs high.

As you can see, below, the LEI® has been a fairly reliable predictor of US recessions in recent years. Not every decline is a strong indicator. According to The Conference Board, a recession signal occurs when a majority of the ten LEI® components is in negative territory and when it has fallen by more than 4.2% over a six-month period. The LEI® has been in this range since the end of last year.

chart of US LEI 6-month growth rate relative to recessions

Could the LEI® be getting it wrong this time around? Even though the overall index has fallen steadily and sharply, there are several places where we are seeing unusual strength for this stage of the business cycle: The stock market has risen strongly, the residential business cycle has turned upward, and (as we have noted frequently before) the labor market remains very tight.

The stock market could drop, of course, since it is overvalued by traditional measures (a topic for another day). But the unusual strength of the labor market is probably the biggest source of uncertainty. While people report poor expectations of future business conditions, their assessment of their own financial conditions has remained much more positive, and aggregate employment levels and job opportunities remain high. This may continue to support consumer spending even as other parts of the economy slow.

I still think a mild recession is likely later this year into 2024, but despite leading indicators it is not a foregone conclusion.

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