Is the Fed in Danger of Starting an Accidental Recession? RPI & Business Conditions Update
There is a lot of debate about the lack of clarity in the Fed’s communication to market participants over the last several months, and markets generally do not like uncertainty. Some recent headlines are talking about an accidental recession. So, can premature rate raises spark recessions? A Fed rate raise in the 1930’s at about this same point in that recovery arguably provoked a 2nd stock market crash while putting the US into a recession it took a World War to lift us out of.
Institutional buyers are aware of these academic parallels even if the average investor is not.
But is that happening now? As readers of my posts know, I do not expect a rate raise tomorrow (9/17/2015). IF one does come, I expect it to be VERY dovish. But rather than wasting time trying to read the Fed’s tea leaves, let’s have a quick look at what the Recession Probability Indicator and current business conditions are telling us.
The most recent reading (June 2015) is STABLE with an RPI score of 17. (20 and below usually favorable, 20+ usually much less favorable). The RPI runs on about a 2 month delay due to the Fed’s data release schedule.
For those of you new to the RPI, it’s a tool for measuring the strength of the American economy. It’s derived from data provided by the Federal Reserve and has demonstrated itself to be historically effective.
The RPI reading suggests that the economy can tolerate higher rates without slipping into recession, counter to what many headlines seem to suggest.
To learn more about the RPI and see an illustration of it at work, CLICK HERE. Make sure you take the time to scroll down to the updated table if you haven’t seen it. You are in for an eye opener.
I’ve also included the most recent business conditions summary from the American Institute for Economic Research below. Their view largely coincides with mine on several issues including the view that the economy is doing okay with no recession on the horizon (as yet).
My opinion is that the Fed is going to raise very slowly over a multi-year period, with the end of that process around a 3% rate several years from now. We’ll see if the future bears out that opinion.
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Chief Market Strategist
ACI Wealth Advisors, LLC.
Process Portfolios, LLC.
Headwinds from China’s slowing growth and a devalued yuan may curb the U.S. expansion, but the risk of a recession remains low. Our Leaders index remained solidly above 50 percent in the latest month, suggesting the probability of a domestic slump is still low.
The CPI, compared with a year earlier, continued to advance for a second straight month in July, but future inflationary pressure has eased. In the latest AIER inflation scorecard, 12 indicators support rising inflationary pressure, compared with 17 in the last month’s report, and eight point to falling inflationary pressure, compared with just three last month. The pullback mainly came from a stronger U.S. dollar pushing down import prices and from improving business productivity. Going forward, should the Fed tighten credit by raising key interest rates, it would amplify downward pressures on prices.
Fed policy makers have long telegraphed their intention to raise short-term rates from near zero this year, but recent market turmoil may have raised fresh concerns about the timing of the first increase in almost a decade. The focus now turns to the mid-September meeting and whether the Fed will use the occasion to begin the normalization process and what policy makers might reveal about the central bank’s future plans.
The recent sharp fall in oil prices, driven both by China’s slowdown and rising U.S. crude output, is creating pressure to lift the long-standing U.S. crude export ban. Proponents say ending the policy would raise U.S. prices, stimulating investment, spurring domestic production, and cutting gasoline prices. In July, the U.S. Senate Energy Committee passed a bill to lift the export ban. Whether the measure will pass Congress and how the Obama administration may react if it does remains uncertain, but an end to the 40-year-old policy may be closer than ever.
Slowing growth in China coupled with a devalued yuan and improving U.S. consumer demand all suggest a widening trade gap with China. That, in turn, may lead China to buy more U.S. Treasury securities, helping to restrain gains in long-term yields just as Fed tightening approaches.
Commodities are still struggling with no short-term relief in sight. But over the medium term, better global growth and a stable dollar combined with the deep price declines that have already occurred suggest that there may be light for raw materials at the end of a long tunnel.
U.S. equities are still getting fundamental support from profit growth. Risks from rising labor costs and higher interest expense may threaten profit margins, but productivity may be the magic bullet that facilitates profit growth and higher wages that can, in turn, boost future spending.
Global equities have been volatile and U.S. investors gave mixed signals with their new investment dollars ahead of the worst declines in Chinese markets. New cash would help support markets, while additional withdrawals from global market mutual funds and ETFs would hurt. Fed tightening remains on the horizon as a potential new source of volatility, especially for emerging markets.
If you’d like to see the full summary just CLICK HERE.
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