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.

How much is too much?  Well, that depends on the subject matter.  In this instance, I am referring to the housing market, specifically, residential real estate.  There are two components to this question of how much is too much; Interest rates and prices.  I want to focus on interest rates for this post.
 
The University of Michigan consumer sentiment survey is a very broad-based survey and includes detailed questions on the housing market.  Specifically, it asks about whether it’s a good time to buy a home because interest rates are low, and whether it’s a bad time to buy a home because interest rates are too high.  In the chart below, I have netted out the two survey answers, and something just pops out at you in the graph.  On a net basis, things have not looked this bleak for the housing market in 40 years.  We also saw today, with the release of the National Association of Home Builders (NAHB) sentiment reading, this poor sentiment is having an effect on home builders.  The index came in at 69, missing expectations of 77 and is down from the peak of 84 late last year.  These two sentiment surveys imply that we are likely at/near the peak in new permit issuance, which leads both new home building and construction labor growth.  Next year could be tough for residential real estate activity, which implies a large slowdown in both employment growth and economic activity next year.  Stay tuned...