THE ECONOMY:
Leading Economic Indicators fall 0.2% in April . . . again.
For the fourth month the LEI hung a minus sign on the wall. It was expected to do so once more and thus it was in line, but the trend remains lower. Moreover the March number was revised lower to -0.6% from -0.4%. We say it often: the revisions tend to show the trend because they compile all of the data and they build the trend. Again, the trend is lower.
The LEI looks out 6 months. That gets the current report close to what the 'start' of the downside cycle the LEI has forecast. It is not really a downside cycle, however, but more of a softening of the expansion that could lead to a downside cycle within the expansion, or if the Fed goes too far, a real downside cycle in a contraction.
That puts the LEI more in line with what the market indicators show. The bond market is not forecasting inflation, and neither is gold. That can mean the economy is 'just right' or it can mean that the growth is going to stop and we have a flat spot or slight contraction, or things get worse if the Fed goes really overboard. Remember, the bond yield curve is flattening with the spread between the 10 year and short term treasuries near 100 basis points. That is close to flat, but it is not. It is also not inverted. Inversion equals recession. We are not there yet, but that is what has many concerned, the stock and bond market included.
If things don't change, as the Fed hikes and the bond market rallies (anticipating lower interest rates due to less demand for money) the spread is only going to shrink, meaning the curve will flatten further. If the Fed wants rates at 4%, then it is taking out another 100 BP in the spread all by itself even if the 10 year holds steady. In other words the Fed will flatten the curve like a pancake all by itself if it keeps going. As it is drying up the money supply as it does this it will put the economy at risk.
Philly Fed positive but another region shows slowing.
New York was negative, but the New York PMI does not receive widespread acceptance because it is newer. Philly is a different story, and the May manufacturing sentiment survey fell to 7.3 from 25.3 (18.0 expected). That is still positive but it is way off pace and an 18 point drop in one month shows it could easily fall into contraction with a modest decline.
It is just a sentiment survey, but many of the regional surveys have now shown some volatility the past three months: down in March, an April rebound, then a dip in May. What do we know about volatility in any market? It indicates change just like volatile weather when a season comes to an end and a new one is starting. Put into context of the manufacturing reports and there is some indication that the nice expansion the past two years is slowing. Whether that will be a slow spot or something worse remains to be seen, but with the Fed hiking, the bond market rallying in its face, and the stock market, despite this week's bounce, still in the bottom half of the year's range, the markets and sentiment surveys are showing there is a general lack of confidence that the economy is going to weather the Fed campaign.
The Fed may be focusing on its price indicators, wage costs, and consumer spending patterns, but as we saw with the last recession, the consumer's impact, while important, is not the only factor in a recession. The consumer remained strong in relative terms to other recessions yet we still were in recession. If businesses sentiment drops and they quit investing to grow supply then we will indeed have a problem with inflation because demand will really outstrip supply.
Thus while the LEI and Philly Fed will be brushed off by the Fed and most market watchers, they are telling a part of the story that the bond market is also telling: things are still expanding thus far, but they are not nearly as robust as they were. A slowdown within an up cycle is normal, and as we have seen the March soft patch was short. That does not mean everything is clear. As long as the Fed stays on course with contracting the money supply, the economy, as the leading indicators suggest, is going to slow. Problem is, history shows the Fed usually goes too far and takes the economy into recession. That is the problem the market faces, and we have to keep that in mind during this rally. So far it looks good, but it is still just getting started, and there is no real indication the Fed is ready to stop hiking. |
