US leading index falls

This is the month-on-month annualised percentage change in my leading index.  The data for the last couple of months are provisional.   Normally, I would regard this as not long enough to call a recession, but since the causes of the recession are not changes in monetary policy, but an artificially induced collapse in confidence as a result of Trump's tariff policies, which I don't see ending any time soon, I think it's more plausible to argue that the economic data are now confirming my a proiri expectations.

Australian recovery probably OK

This chart shows YoY changes in my Australian leading and coinciding indices.  The leading index has been brought forward by 6 months, which gives us a forecast of what is likely to happen to the economy.  It suggests that economic activity is likely to accelerate.

However, my leading index is based on indicators which would normally lead recoveries and recessions.  There is no recent precedent for the damage wreaked by a trade war, and worse, by random changes in tariff levels, up one week and down the next.  These would be picked up by confidence indicators, both business and consumer.  But although consumer confidence rose sharply from 2023 lows, it has merely levelled off since January.   Business confidence is still holding up.  The most up-to-date activity indicators, the PMI series, are, so far, still rising.

Unlike the data in the US, which are already suggesting a slowdown at best and a recession at worst, Ozzie data still point to a recovery.   I'll go with that for now.

China has further to fall

The chart below shows the year-on-year percentage change in my leading and coinciding indices for China.  A coinciding index is designed to follow the economic cycle, while a leading index is designed to lead the economic cycle.  In the chart, the leading index has been plotted with a nine months lag, so that its peaks and troughs approximately coincide with the cycle.  From 2014-2018, the leads were longer, and during China's repeated covid lockdowns over the last 3 years, they were shorter. 

The leading index appears to have troughed, consistent with recent shifts in monetary policy by the People's Bank of China.  But as always, these won't affect the economic cycle for several months.  It is likely that the real economy will only bottom in the middle of 2024. 

What does this mean for the world economy?  China's economic importance is overstated by its official GDP data, but I estimate that it is something between 10 and 15% of the world economy.  In my calculations, I use a weight of 11%, which is perhaps at the lower end.   This compares with the US at ~21%, the Euro Area/Zone of 17%, Japan at 6%, India at ~5% and the UK at 3%.  Because currencies move around a lot, these weights are based on PPP (Purchasing power parity) exchange rates.  (You might see news reports which give different weights, but these often use current exchange rates, which are volatile and can easily change direction.)

So, the US is embarking on a new economic upturn, Europe and the UK are still mired in recession, and Japan is beginning a slow recovery.  China's weak economy will retard world growth.  From an Australian perspective, it will also mean bad news for the prices of Australia's exports, including iron ore, which is already reflecting economic reality, and is falling fast.

China also faces major structural, long-term negatives for growth, but cyclical indices like my leading and coinciding indices aren't designed to pick these up.   Among the negatives China faces are its declining population, its massive housing crisis, and its continued skew away from private consumption.   Given these long-term structural issues, the traditional Chinese stimulus involving massive debt-financed residential housing and infrastructure development may not be feasible or even work.  

This chart shows the gap between the official GDP data and my GDP estimate.   My estimates, and those of other people, suggest that China's actual GDP is 1/3rd or more below its official level.  Note that my alternate GDP estimate is falling even though the government's estimate for GDP is still rising.

My US leading index has turned up

 My US leading index, designed to give a year's warning of impending changes in the business cycle, has been rising since May.   The (lagged) correlation with the cycle has been excellent, up until the Covid Crash and its consequences.  And the gap between what my leading index predicted GDP should have been doing and what it actually did has widened.   Why?

My leading index is a combination of monetary measures, momentum measures of the economy, sentiment, and a variety of other leading indicators, all of which have in past led the business cycle.  What it doesn't contain is the impact of fiscal stimulus or contraction, and what it can't forecast is what economists call exogenous factors, such as Covid, war, weather, etc.   

The gap between what GDP should have done and what it did is due, I think, to two factors.  The first is the massive fiscal stimulus of Biden's "Inflation Reduction Act".  This didn't just cause plenty of government spending, which directly, and rapidly, expands overall economic activity, it also stimulated private sector spending, especially in the renewables sector.  The second is the burst of "revenge spending" as people took advantage of the end of lockdowns to travel, eat out and go to shows. 

In the economy, everybody's spending is someone else's income.  So stimuli have ripple effects, which only gradually tail off.   If a government builds a new freeway, those who work on it have incomes, the cement and steel companies have higher sales, and hire more people, and so on.  This higher income leads in turn to more spending, which leads in turn to more income.  You get the picture.  This means that these ripple effects can amount to much more than the original stimulus, particularly if business confidence is increased.  

The ripples of both these stimuli will fade.  For fiscal stimulus to keep on expanding the economy, it must be steadily increased, and that won't happen.  So growth will slip to more normal levels, but only slowly, as the "ripples" fade.  Offsetting that is the improvement in leading indicators, so growth will likely remain reasonable all this year.

In a non-recession year, incumbents tend to win:

First-term incumbency typically provides an advantage — unless there’s a recession during or just before the election. When there is no recession, the incumbent has always won in the post-World War II era. Goldman Sachs Research estimates a 15% probability of a recession over the next 12 months (equal to the average historical probability).

(Source: Goldman Sachs)

Australia: How deep the recession?

 Here, I said that Australia might reach a lower turning point in its economic cycle later this year, but that it wasn't clear just how deep the recession might get.

The chart below compares the change in the "cash rate" (The Reserve Bank's discount rate) with my coinciding index.  The change in the cash rate has been plotted inverted, because when it rises economic activity slows, and it has been plotted with a lag, because it takes time to take effect.  This gives us an implicit forecast of what economic activity will do over the next 10 or so months.

This indicator points towards a recession lasting to the end of this year, deeper than any recession in the last 30 years.

The chart below shows the year-on-year change in real (= inflation-adjusted) money supply compared with my coinciding index.  Again, it’s plotted with a lag, because changes in money supply take months to have an effect.  It hasn't yet conclusively bottomed, and is lower than it's been since the very deep and very painful "recession we had to have" in 1990.  

My conclusion:  we are likely to face much more than a "growth slowdown" or a "soft landing".  The consensus always gets this wrong.  It starts off by saying monetary policy changes will have little effect, then shifts to forecasting a "soft landing".  Then, as the data worsen, the consensus says, "well, we might have a mild recession".  At the bottom of the recession, the consensus doubts that there will ever be a recovery, and if there is, opines that it will be slow.

The only factor which might mitigate this recession is a rapid rebound in China. The Chinese government is finally becoming more serious about stimulating demand, but there are always lags involved.  Plus, the traditional route to stimulate the economy in the past has been by force-feeding the housing market.  Given the steady decline in the population growth rate, will that work this time?  And if European and US economic activity are slowing as fast as I think they are, will any Chinese stimulus be effective?  We shall see!

Has my Oz leading index bottomed?

 I haven't calculated my Ozzie coinciding and leading indices for 3 years.  I had a few personal issues, and just updated the bare basics of my data banks.  But I have at last updated all (more or less) of the time series in my Australia collection, and so I can run my programs to calculate my indices.

First, my coinciding index.  This is designed to track the business cycle.  In a commodity-exporting economy, GDE (Gross Domestic Expenditure) is often a better guide to the state of the economy than GDP, and it's certainly more amenable to policy.  The RBA and the government can influence domestic demand, but they have little power over exports.   (GDE= GDP - exports + imports.)

The chart below shows the de-trended average for GDP and GDE and for my coinciding index.  Both are extreme-adjusted, to help minimise the impact of the Covid crash.  However, as with other economies, the downward spike in early 2020 and the rebound spike in 2021 have been muted, not eliminated.  Note that there was a second covid lockdown in 2021.

I haven't yet determined the dates of the Covid recession, as I need to look at individual time series to pin them down, but you can imagine there's a yellow bar showing a recession starting early in 2020 and ending more or less in mid-2020.

Why do I use my coinciding index as cycle referent, instead of GDE?  Because of the lags involved in quarterly data.  The national accounts are available only until Q1 2023; my coinciding index is calculated until June 2023, and I'll be able to make estimates for July in just a couple of weeks.  (The coinciding and leading indices do not contain quarterly time series)

OK, assuming we accept that my Oz coinciding index is a good guide to the cycle, then we can compare it with my leading index, using my coinciding index as the cycle referent.

I've shown the first chart over a long time period to show that my leading index has a consistent lead of around 6 months to the cycle.  Again, note the distortions in the data caused by Covid.  This chart and the one below it show year-on-year changes, not de-trended data.

This is what it looks like over a shorter period:

The key take-aways from this analysis are:

1.  My Oz coinciding index correlates well with the cycle
2.  My Oz leading index leads the cycle by ±6 months
3.  It has started to turn up, suggesting that the Australian recession will be short and that the economy will be expanding again by end-year.
4. However, the recession will likely be deep, if the leading index is any guide.

I'll do some more work to see just how deep, over the next few days.

China should be stronger than this

I finally got around to updating my China data and indices.  And, according to my China diffusion index, which leads my coinciding index by 7 months, China's economy should be stronger than it appears to be.   It is however true that my China coinciding index is growing reasonably, on a month-on-month basis.  Yet there are so many signs of weakness. 

This is possibly because of the plunge in China's exports, now heading towards GFC lows:

And that in turn is because the world economy (or at least, the manufacturing chunk of it) is so weak:

I think I need to dig deeper.  I'll get back to you.   (Click on each chart to see it more clearly)