The U.S. economy is growing. How much and how well is open to debate, particularly in Washington, but in the 10th year of expansion, the news continues to be largely positive.
But another recession is inevitable. Do any signs suggest that path? Only a few, for now.
ClearBridge Investments employs a 12-indicator proprietary Recession Risk Dashboard to track these possibilities, using traffic light signals (green for expansion; yellow for caution; red for recession) for each indicator. At present, 11 of the 12 indicators continue to flash green.
This suggests the likelihood of a recession in the next 12 months remains below average. To the contrary, it signals that the U.S. economy likely will continue to expand over the next year.
Our Recession Risk Dashboard has been steady, experiencing its first two changes in 2018 in August. Corporate profit margins are growing steadily as revenue growth, tax reform and firming oil prices take hold. This caused our profit margins indicator to improve from yellow to green.
By contrast, the money supply indicator moved down, from green to yellow. Many financial stress indicators tend to roll over ahead of market peaks and recessions. Money supply growth has been slowing for several months against the backdrop of tighter Federal Reserve policy and increased short-term debt issuance. This could reflect an economy potentially less capable of withstanding liquidity shocks. As liquidity declines, the financial system and economy are less able to weather stresses or shocks, elevating the risks of recession or crash.
Recent Fed actions to concurrently raise short-term rates, while reducing the size of its balance sheet, have resulted in less cash moving through the financial system. Increases in short-term rates slow money supply growth. As rates rise, the opportunity cost of holding money in non-interest-bearing accounts rises. Fed balance sheet unwinding attracts cash off the sidelines in search of higher yield. This also happens when the U.S. Treasury issues more debt (both to fund the larger budget and tax reform), as investors convert cash holdings into Treasury securities.
