Back at the end of June I posted a note called "Shot across the Bow".  In this post, I showed my leading economic health model and I said snidely something like, if you squinted, you could see the model just turned negative.  Well, as you can see in the updated chart below, squinting is no longer required!



What is more important now is the color of the line in the chart.  It is now purple and confirms the economy, in terms of economic liquidity, is running on fumes, being choked off.  As you can see with the last three recessions, purple means a very high probability of a recession beginning sometime in the next 12 months.  The gray-hairs in Washington can say anything they want to us, but their noses are about to begin growing.

Things have been getting very interesting lately on the topic of the economic future of the US, at least from my perspective.  I have written recently, in the ALCOTalk newsletter, about being ready for the recession countdown clock being triggered.  Two of the models I referred to are long leading models.  That means they are built to look ahead roughly two years.  Things got really interesting this week because a couple of my short leading models are now flashing warnings.  One example is the model below, it is my "Leading Economic Health Model".  It is built to provide an average recession lead time of 12 months.  If you squint hard, you will notice on the far right side of the chart, the model is now negative.  This model is important now because, first, there are no data revisions to this model, a negative is now a negative.  Second, it shows that economic activity is likely to deteriorate pretty quickly over the next 12 months.



I don't want to steer this discussion to "how bad" or "how long" a potential recession could be.  More importantly, I want to point out today, that in every recession since 1954 (all the data I had), the FF rate has fallen an average of 51.64% DURING the recession.  Even more important is that from peak to trough surrounding those recessions, the FF rate eventually fell an average of 76.24% from its ultimate peak.

Obviously, it's time to bring up the old "crystal ball" joke, I don't have one.  However, the three models now flashing warnings have historically been very accurate.  Hopefully this helps give you some color on the duration discussions your ALCO's should be having on future assets and liabilities.  I will also point out that you shouldn't forget to include optionality in those discussions.   

Have a great 4th of July holiday!

Setting records is usually a great achievement, but Jerome Powell has just established a new record that he really should not be proud of.  I fear there are more records to come.

Economies thrive on liquidity and leverage.  When both disappear, so too does economic growth.  The concept of "economic liquidity" is driven by how freely available liquidity is being used to drive economic expansion and wealth generation.  A couple of important drivers of economic liquidity are the cost of borrowed money and access to credit.  Sadly, neither of these drivers are moving in the right direction.  What's worse is when you add wealth destruction (equities, bonds, housing and credit losses) to the equation.  This is a recipe for serious economic pain in the future.

Below is my economic liquidity model.  You have seen this in the past.  It is a very good predictor of both GDP growth and the ISM manufacturing index roughly two years ahead in time.  As you can clearly see, the US economy is on the edge of an economic liquidity waterfall (rapidly diminishing economic liquidity) heading into the 2nd half of this year.  Worse yet, the pace of actual liquidity contraction set for 2023 and into 2024 has set an all-time new low.  I expect this to get worse before it gets better seeing that the Fed is still chasing an inflationary monster (more tightening of monetary conditions).  What this model is saying is we should expect a deflationary environment (think recession and falling prices) next year and into 2024, this appears to be the Fed's weapon of choice in slaying the inflation dragon. 

I will be expanding on this discussion, relative to specific banking risks under these conditions, in the next couple of ALCOTalk newsletters and during my presentation at the MBA CFO conference in September.