Recession Alarm Bells Are Ringing
Recession indicators are ringing loudly. Yet, the Fed remains focused on its inflation fight, as repeatedly noted by Jerome Powell following the March FOMC meeting. During his press conference, he specifically made two critical comments. The first was that inflation remains too high and is well above the Fed's two-percent goal. The second was that the bank crisis would tighten lending standards which would have a "policy tightening" effect on the economy and inflation. Lending conditions have tightened markedly, and such tightening always precedes recessionary slowdowns. While the market is starting to price in just one additional rate hike by the Fed, the "lag effect" of rate hikes remains the most significant risk. The problem for the Fed is that the economy still shows plenty of strength, from recent employment numbers to retail sales. However, much of this "strength" is an illusion from the "pull forward" of consumption following the massive fiscal and monetary injections into the economy. This is why calls for a "recession" have been early, and the data continues to surprise economists. However, the inability to sustain the current standard of living without debt increases is impossible. Therefore, as those liquidity impulses fade, the consumer must take on increasing debt levels. The problem is that the Federal Reserve and the Government fail to grasp that monetary and fiscal policy is "deflationary" when "debt" is required to fund it. Many "recession indicators" are ringing alarm bells, from inverted yield curves to various manufacturing and production indexes. Here we focus on those related to economic expansions and recessions. The first is our composite economic index comprising over 100 data points, including leading and lagging indicators. Historically, when that indicator has declined below 30 (as it has now), the economy is either in a significant slowdown or recession. Just as inverted yield curves suggest that economic activity is slowing, the composite economic index confirms the same. The 6-month rate of change of the Leading Economic Index (LEI) also confirms the composite economic index. As a recession indicator, the 6-month rate of change of the LEI has a perfect traffic record. Of course, today's debate is whether these recession indicators are wrong for the first time since 1974. The massive surge in monetary stimulus (as a percentage of GDP) remains highly elevated, which gives the illusion the economy is more robust than it likely is. As the lag effect of monetary tightening takes hold later this year, the reversion in economic strength will probably surprise most economists. As the Fed continues to hike rates, the more considerable threat remains deflation from an economic or credit crisis caused by overtightening monetary policy. History is clear that the Fed's current actions are once again behind the curve. While the Fed wants to slow the economy, not have it come crashing down, the real risk is "something breaks." Each rate hike puts the Fed closer to the unwanted "event horizon." When the lag effect of monetary policy collides with accelerating economic weakness, the Fed's inflationary problem will transform into a more destructive deflationary recession.
