Leading economic evidence continues to teeter at levels that have always and only been breached in recessions, but the sharp deterioration we initially observed late last year has been followed by modest stabilization - though still near the area that has historically marked the entry to economic contraction. The uncertain outcome and the incomplete view evoke a line from Leon Russell - "I'm up on a tightwire, one side's ice and one is fire... but the top hat on my head is all you see."
We can respond to the easing of downward momentum in several ways. We could pound the table about recession risk, based on the fact that previous breakdowns of the same magnitude in leading indicators have always resulted in recessions. Alternatively, we could emphasize the more favorable recent data and abandon our concern about recession, particularly because of the significant decline in new unemployment claims (though there is a great deal of seasonal impact here, and new claims also tend to be lagging indicators by about 3-6 months - see Leading Indicators and the Risk of a Blindside Recession ). The problem with both of these responses is that, in our view, each would overstate the case, and grasp at interpretations that are not supported by the data.
The interpretation best supported by the data is that recession risk remains very high based on the leading evidence and the typical outcomes that have resulted, but that the rate of deterioration has eased significantly, and it is simply unclear whether this is a temporary pause or a reversal. Rather than overstating the case one way or another, we remain strongly concerned about recession risk, but recognize the recent stabilization and the potential for a low-level continuation of that. On the indicator front, the economic data over the coming week could be informative (especially the introduction of the Conference Board's revised LEI, the Chicago Fed National Activity Index, and unemployment claims), but if the new data also muddles around near the flat-line, it will essentially reinforce the overall view that the global economy is close to slipping into recession, but is at least temporarily stabilizing.
It is shortsighted to view the actions of the Fed and the ECB as costless, because the difficult question comes later - whether they will be able to reverse their actions and shrink their balance sheets without major economic disruption. This will require the financial assets they presently hold (sovereign debt and mortgage securities) to be willingly absorbed back by the private sector. From my perspective, central banks are playing a dangerous economic experiment, that has its main constituency - the banking sector - as the primary beneficiary. Of course, if the Fed and the ECB are unable to reverse these transactions, or if any of the assets they hold lose value for any reason (sovereign default, counterparty failure, etc.) they will ultimately have printed enormous volumes of currency, not for public benefit, but to reduce the losses experienced by the bondholders of financial institutions.