ECRI Index annualized change almost a lock for double dip territory

The ECRI Weekly Leading Index (WLI), a measure of future U.S. economic growth stands at 120.6 unchanged from a week ago. We first began actively talking about the WLI in April as a predictive indicator for either sustained recovery or a double dip recession. However, the gauge most of us are looking for is the annualized year-on-year change. Reuters says:

The index was last below 120.6 in the week of July 24, 2009, when it measured 120.3, according to ECRI. The index’s annualized growth rate fell to minus 9.8 percent from minus 9.1 percent the previous week, originally reported as minus 8.3 percent.

The index is saying that growth is slowing quite rapidly. But there is no imminent recession on the horizon.  However, what happens by the end of the year or in 2011 is another story. David Rosenberg mentioned in June that a minus ten reading is a recession lock for the entire 42 years of ECRI data available. The minus 9.8 reading is about as close to a double dip warning as you are going to get from the WLI. These numbers are telling us that the manufacturing and inventory led recovery is so stalled that a double dip recession is likely within six months.

And to wit, yesterday we saw some fairly abysmal numbers from the Philly Fed and Empire State manufacturing surveys. Here are the numbers from the Empire State survey which is for the state of New York. Zero is the demarcation point dividing contraction and expansion.


The Empire State Manufacturing Survey indicates that while conditions for New York manufacturers continued to improve in July, the pace of growth in business activity slowed substantially over the month. The general business conditions index remained positive but fell 15 points, to 5.1.The new orders and shipments indexes were also positive but lower than last month’s levels. Employment indexes dipped as well, with the average workweek index falling below zero for the first time this year.

The Philadelphia Federal Reserve Bank’s business activity index also dropped from 8.0 in June to 5.1 this month. Again, any reading above zero represents expansion.

I have recently given a double dip fairly high odds i.e. 50-60%. This is not the 100% you get from the WLI but the WLI is just one tool. Nevertheless, the punderati are seriously playing down how much the US economy is slowing. Even bears like Stephen Roach only say 40%. I believe Nouriel Roubini is at 20%. And if you listen to the financial news, you get the sense there is almost no chance of a double dip.  Why are credit, manufacturing indices, and consumer prices dropping if that’s the case. On what are analysts predicating their rosy view that the double dip is an outlier?

Here’s how I called it in March:

I expect the following to occur:

  1. Public pressure to withdraw monetary and fiscal stimulus will work and stimulus will be reduced quicker than many anticipate – beginning sometime in early 2010. The Fed has already said it will stop buying mortgages in March and the Obama Administration is now focused on deficit reduction as evidenced by the paltry jobs bill just passed.
  2. The fiscally weak state and local governments will therefore receive little aid from the federal government. This will result in budget cuts, tax increases, and layoffs by the end of Q2 2010.
  3. At the same time, the inventory cycle’s impact on GDP growth will attenuate. By the second half of 2010, inventories will not add considerably to GDP.
  4. Meanwhile, the reduction of Fed support for the mortgage market will reveal weaknesses there. Mortgage rates may increase, decreasing housing demand.
  5. Employment will be weak in this environment, leading to another spate of defaults and foreclosures.
  6. The foreclosures and weak housing demand will pressure house prices and weaken lender balance sheets, especially because of second-lien exposure. This will in turn reduce credit growth.

I expect the weakness in GDP from this scenario to be evident sometime in the second half of 2010. The only thing in this sequence of events which is supportive of asset prices, credit and GDP growth is that the government will still be manipulating mortgages even after the Federal Reserve stops buying MBS paper. Fannie and Freddie are the only game in town in securitized mortgages, buying the vast majority of paper.

As they are now government entities with an unlimited backstop from the U.S. Treasury for losses, the nationalization of America’s mortgage problem I had foreseen can begin. I understand Fannie and Freddie have been shifting their excess funds from the term Fed Funds markets to Treasury Bills. This may be because of a regulatory mandate to achieve more liquidity and may help explain why the Fed Funds rate is creeping up to the upper bound of the Fed’s policy range. Whether this liquidity policy is in anticipation of the need to use Fannie and Freddie’s balance sheet is unknown. In any event, if Fannie and Freddie are used to forestall weakness in the mortgage market, they will eventually suffer huge losses.

Will this be enough to prevent a double dip? I think not, but you can bet the Obama Administration will try.

The mindset will not change; a depressionary relapse may be coming

There is no stimulus coming either on the monetary or fiscal side. Moreover, it remains to be seen whether the Bush tax cuts for the wealthy will be preserved. Even Sir Alan Greenspan has come out against their preservation. My sense is that this recovery will have to be self-sustaining to continue because there will be no extraordinary measures coming from government to aid it. I doubt that it is self-sustaining. But the low mortgage rates are helpful. Let’s hope incipient signs of employment growth gather steam.

If employment does not gather steam, a double dip is likely. Where do see equity, bond and house prices in such a scenario? I see bond prices higher, equities and housing lower.

  1. Gloomy says

    On the money, Ed. Great work.

  2. Evan says

    Hi Ed. I was reading in the Christian Science Monitor yesterday about how two time-tested ways of tracking the economy, the yield curve and the ECRI, are sending opposite signals. You can read the article here:

    What’s your take on this?? Thanks.

    1. Edward Harrison says

      I think you have to look at all the indicators. There was an article by Bloomberg’s Caroline Baum in the links a few days ago talking about the yield curve which has been a good predictor of recession. The yield curve is still very steep (although it is becoming less so). In the past, inversion has meant recession, but that is because the Fed has pushed up short rates.

      Today, they are not doing that. So if a recession came, it would be the first post-war recession not caused/preceded by the Fed hiking rates. But, with short rates at zero percent, the yield curve can’t invert. Either we have to believe this makes recession impossible (I don’t) or we have to understand the yield curve may be less predictive.

  3. demandside says

    I continue to worry about reliance on ECRI’s leading indicators. Having done some work a couple of years ago on the components of this index, it runs in mind that they were canted heavily toward market indicators. And below, something from a year ago.

    With corporations hoarding cash, evidence persists that we are still in a debt-deflation recession that has not abated, but was only mitigated for a time by the stimulus and by inventory rebuild.

    Aug 14 (Reuters) – A U.S. future economic growth
    gauge rose in the latest week, as its yearly growth rate surged
    to a 26-year high, suggesting that recovery will commence at
    the briskest pace in decades, a research group said on Friday.

    The Economic Cycle Research Institute, a New York-based
    independent forecasting group, said its Weekly Leading Index
    rose to a 47-week high of 123.9 in the week to Aug. 7 from a
    downwardly revised 121.7 the prior week, which was originally
    reported at 121.8. Meanwhile, the index’s annualized growth rate leapt to a
    26-year high of 13.4 percent from last week’s five-year high of
    10.4 percent, which ECRI originally reported at 10.5 percent. It was the index’s highest yearly growth rate reading since
    the week to Aug. 26, 1983, when it stood at 13.9 percent. “With WLI growth surging, the odds are rising that the
    early stage of this economic recovery will be stronger than any
    since the early 1980s,” said Lakshman Achuthan, Managing
    Director at ECRI. Achuthan recently told Reuters that the national recovery
    would be stronger than many expect, though signs of such strong
    growth will not be apparent until sometime next year. “Next year, looking back you’ll see that GDP, industrial
    production, sales, and even non-manufacturing jobs growth —
    where 91 percent of Americans work — began rising as recovery
    took hold,” Achuthan said.

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