Leading economic indicators, an inverted yield curve, and a contracting money supply all indicate that a recession is coming. And yet consumer spending remains strong, hiring continues, and unemployment is at historically low levels. The Conference Board’s Leading Economic Index was down 0.6% in April and is now down almost 9% since its peak in late 2022. This type of downturn in the leading index has proven to be a reliable indicator of an impending recession. At this writing, the 10-year Treasury yield is over 50 basis points below the two-year yield, an inversion that has proven both deep and persistent. Inverted yield curves are a classic precursor to recessions. The money supply, measured by M2, has contracted over 3% so far this year and is down over 4.5% over the past twelve months. This is the first sustained contraction in the money supply in US history, so it is difficult to predict the extent and timing of its impact, but if expansions in the money supply can stimulate growth, contractions should operate to tamp down demand, growth, and inflation. Annual growth in the money supply peaked at 27% in February of 2021, driven by the COVID stimulus payments. Contraction in the money supply may prove to be a powerful antidote to inflation, but since we have limited experience with it, its precise effects and time lags are unknown.
Personal consumption (PCE) expanded 2.52% in the first quarter; however, much of that was concentrated in January. Corporate profits were down 5.1%, continuing a trend from the prior two quarters. Corporate profits are now down year-over-year.
At the same time, retail sales were up 0.4% (MOM) in April, payrolls rose by 253,000, and unemployment remained at the historically low level of 3.4%. Real GDP increased 1.3% in the first quarter of 2023, according to the second estimate, but that does represent a deceleration from the pace achieved in the back half of 2022. Sales were “up” 1.6% YOY in April but would be negative 3.2% if adjusted for inflation.
If it seems like every bit of economic data contradicts the prior read, it is because, like crosscurrents at slack tide, economic indicators are often mixed at turning points. However, taken together, the most reliable indicators show that the economy is gradually slowing down. The prudent course for investors and decision-makers would be to prepare for a recession, although the hoped-for soft landing remains a possible outcome.
Source: U.S. Bureau of Economic Analysis, fred.stlouisfed.org