Never Mind Tea Leaves, Here’s A Strong Signal From The Economic Dashboard

We’ve been seeing more and more commentaries discussing bad stuff that can happen when the Fed tightens policy and, as a result, the yield curve flattens. (See, for example, this piece from Citi Research and ZeroHedge.) No doubt, the Fed’s rate hikes will lead to mishaps as they usually do—in both markets and the economy. But most forecasters expect the economy to expand through next year, believing that the Fed and the yield curve aren’t yet restrictive enough to trigger a recession.

We won’t make a full-year 2018 forecast here, but we’ll share one of our “dashboard” charts that supports the consensus view for at least the first half of the year. With one methodological change to a chart we published in August, we’ll look at the following indicators, which together have an excellent track record predicting the business cycle:

The idea is that the economy tends to turn over when investors lose money, borrowers find it hard to obtain financing, business earnings weaken, and banks struggle with a flat or inverted yield curve. Here’s a history of all four of those indicators in the quarter before and the quarter of the last nine business cycle peaks, although with less data for lending standards, which the Fed began surveying for the first time in mid-1990:

With that history as our background (in charcoal gray), our dashboard highlights the most recent data, along with our fourth quarter estimates for asset price gains and S&P 500 earnings growth:

In our view, the above chart is the best way to judge recession risks—with a strong reminder of how current conditions compare to the conditions that shaped past business cycles. That comparison looks favorable as of mid-December, just as it did in August. Here are our takeaways, moving from right to left along the chart: