The Leading Indicators are Signaling Recession
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
U.S. Treasury Secretary Janet Yellen recently stated: "You don't have a recession when you have the lowest unemployment rate in 53 years." Let's hope she is correct.
As logical as her statement seems, it may look equally foolish in short order. As I will explain, hope leads me to believe Yellen does not appreciate the time it takes for tighter monetary policy conditions and reduced liquidity to cause economic deterioration.
The Fed is tightening monetary policy at the fastest pace in over 40 years. Furthermore, the economy is more leveraged than at any time in history and, therefore, more sensitive to interest rate increases. It is naïve to assume a recession is not probable because a lagging economic indicator, like employment, is robust.
This article explores the “hope” framework, developed by Michael Kantrowitz, chief investment strategist of Piper Sandler. HOPE is an acronym describing the lags and the sequence in which economic activity weakens before a recession.
Michael's HOPE model consists of Housing, New Orders (ISM), Corporate Profits, and Employment.
His framework acknowledges that the most interest rate-sensitive sectors are the first to feel the brunt of tightening monetary policy. These sectors often serve as leading economic indicators. As tightening monetary policy dampens economic activity in interest rate-sensitive sectors, other sectors and facets of the economy feel the impact of higher rates. HOPE illustrates the various lags or the time it takes for rate hikes to affect economic activity fully.
Yellen may not acknowledge monetary policy lags, but Jerome Powell and many Fed members are fretting about their inability to judge how 2022's interest rate hikes will impact 2023's economic activity. Did they hike too much? Or might they stop too soon, keeping inflation pressures too high?