What it is, why it’s flashing a recession warning

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A monthly gauge of what could lie ahead for the US economy is flashing a recession warning sign.

The Leading Economic Index dipped by 0.4% in September from August and is down 2.8% since March, according to the Conference Board, an independent group that publishes the index. The latest reading is below a threshold that the organization considers a recession signal.

“Its persistent downward trajectory in recent months suggests a recession is increasingly likely before year-end,” said Ataman Ozyildirim, senior director of economics at the Conference Board.

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Yet at this point, some experts say, the index’s latest reading is not indicative that a recession is imminent.

“The question is whether it is going to continue to deteriorate,” said Brian Bethune, an economist and professor at Boston College. “It’s a mixed signal, I’d say.”

Other recession hallmarks are mixed

A recession is generally defined as a broad-based, significant decline in economic activity that lasts for more than a few months, according to the National Bureau of Economic Research, a non-government agency that identifies recessions.

While the economy did contract in the first two quarters of 2022 by 1.6% and 0.6%, respectively, other factors that characterize a recession — such as widespread jobless claims and a broad drop in personal wages and salaries — have not materialized.

Some LEI changes are ‘not significant’

The Leading Economic Index is based on 10 components that detail factors like jobless claims, manufacturing orders and performance of the S&P 500 stock index, a broad barometer of how US companies are faring. Some of those components show significant weakness — the S&P is down 20.3% year to date through Oct. 24 — while others do not.

For instance, while the average weekly hours worked in manufacturing has trended downward on a monthly basis since February when it was 41.6, September’s reading wasn’t too far below that at 41.1, according to the US Bureau of Labor Statistics.

“A decline of a half-hour per week is not significant,” Bethune said.

Initial jobless claims — another data point used in the index — also do not point to the kind of broad-based job loss that comes with a recession. The most recent data shows 214,000 initial claims were filed in the week ended Oct. 20, which is a reduction from 226,000 in the previous week.

That could change, of course.

Fed rate hikes could cool the job market

The Federal Reserve is expected to continue pushing up interest rates in an effort to bring down persistent high inflation. The general idea is that by making the cost of borrowing money more expensive, spending is reduced, which in turn will slow consumer demand and ease inflationary pressure.

However, reduced demand also can translate into job and/or income loss — which generally is the primary pain point for households in a recession. Yet despite the Fed’s moves, unemployment remains low, at 3.5%, according to the latest data from the US Bureau of Labor Statistics.

“Hard data on a monthly basis do not suggest the labor market overall is cooling fast,” said Alessandro Rebucci, an associate professor of economics at Johns Hopkins University.

“There are pockets of the labor market that have shed jobs, but it’s not widespread job loss,” he said.

‘We are in new territory’

Of course, the index’s 10 components will change before its next reading. For instance, another data point used — the Consumer Confidence Index, also published by the Conference Board — already is now lower than when the Leading Economic Index was published Oct. 20. At that point, consumer confidence had increased for two months.

In other words, the data is constantly changing and is not all headed in a straight line up or down, making it hard for economists to say with certainty what’s on the horizon.

“We are in new territory and don’t fully understand everything that’s happening,” Rebucci said. “It’s hard to form accurate expectations of where the economy is going.”

Correction: This story has been updated to reflect the correct name of the National Bureau of Economic Research.

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