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Is the US economy falling into recession?
February 2016
Recent equity market volatility and increasing concerns about economic growth in emerging markets has turned the spotlight onto
economic performance in the world’s largest economy. The US economy has grown for seven consecutive quarters, with the last
negative GDP reading coming in Q1 2014 which was driven by poor weather. In the final quarter of 2015, growth slowed to an
annualized pace of 0.7%, stoking worries that the economy may be heading for a recession.
Data from the US has been mixed. Most notably the manufacturing sector is clearly struggling and is one area of the economy which
is in recession. The chart below shows the clear split between performance in the manufacturing sector and the service sector. The
critical value of the index is 50. Below this level signals contraction and a reading above 50 signals growth. Oil producers have been
hit hard by the lower oil price. At the same time, those manufacturers which export their goods have had to deal with a sharp
appreciation in the US Dollar. But in contrast, the service sector continues to expand with the lower oil price acting as a tax cut for
consumers.
US Institute of Supply Management Surveys – Manufacturing v Services
And it is worth remembering that manufacturing is now of less importance to the US economy than it was in the past. Manufacturing
accounts for only around 14% of US payrolls, whereas the service sector accounts for almost 86%. For this reason, the service sector
ISM index should be a better predictor of a growth. The big question is whether the weakness in the manufacturing sector will feed
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through into weaker service sector performance. The service sector ISM index is currently 53.5, above the expansionary mark of 50
and signaling growth. It has however dipped from a high of almost 60 in the middle of 2015, so there are signs of activity slowing. If
this index were to fall below 50, it would be one indicator that economic growth in the US is slowing more sharply.
Is the US headed for recession?
Current economic data does not suggest that the US is in recession. To gauge if the economy is heading in this direction it is
paramount to track leading indicators as they best predict future growth. They include areas such as; consumer confidence, business
surveys, new orders and inventory levels. Labour market data often grabs the headlines in the US and continues to show that payrolls
are rising at a strong level each month. The problem with this type of data is that it is backwards looking and tells us what was
happening in the economy last month, or even further back. Although useful to help gauge the strength of past growth, such data is a
poor predictor of future performance.