Recession Watch 2013: Term Spread Probability Series

With the weak economic recovery lagging through its fourth continuous year, its sensible to start looking for clues, however so slight, of the possibility of oncoming recession.

First, let’s remember that while the NBER makes the official call of both the “peak” of a business cycle expansion and the “trough” of the subsequent recession, their officiating is delayed to say the least.

For a more “real time” assessment of the prospects of recession, various methods of number crunching have been formulated to distill out a basic probability assessment from several underlying macro series data sets.

One popular statistical method is the yield-curve based “Term Spread” probability method.


Spearheaded by economist Professor Arturo Estrella of the Rensselaer Polytechnic Institute, this method derives a probability of recession from the spread between long and short yields (10-year and 3-month) and is by all accounts the standard for recession probability forecasting.

The latest data indicates that the probability for recession is remains elevated with a January 2014 probability (the probability that there will be a recession by that date) of 4.4%.

Keep in mind that a positive indication using this method would require this probability to reach 30% so while the probability is clearly rising, the current probability is still quite low.

Recession Watch 2013: Piger Probability Series

Last year I reported on a relatively new recession probability indicator (… the “markov switching” series recently introduced to the Fed FRED/Blytic) that was giving a pretty clear, though preliminary, indication of probable recession.

While I noted that the series was highly revised, I pointed out that even taking into account the revisions, the series was giving a recession signal since using just the "maximum" reported values (values that had been all been revised lower) the reporting 20% probability was very unusual and typically associated to oncoming trouble.

In the latest release, the April data (... there is a reporting lag) indicates that the probability of recession has increased to 3.08% while the standout August 2012 value (that initially peaked interest in this series) has now been revised to 1.22%.

It's important to note though that the point of my prior post was to highlight just the "maximum" reported values and while the latest release revises down August's 19.6% and reports an additional low probability for the latest month, it makes no difference... the fact remains that this series has NOT given such a significant over estimate of recession without there being a probable recession ahead.

Now clearly, there could always be a first time... this is just estimated data... but the prior 19.6% reported figure clearly argues for following this series very closely in the coming months.  

ISM Manufacturing Report on Business: May 2013

Today, the Institute for Supply Management released their latest Report on Business for the manufacturing sector indicating that manufacturing activity slumped into contraction territory in May for only the second time since August of 2008.

At 49.0 the purchasing manager’s composite index (PMI) declined 3.35% since April and dropped 6.67% below the level seen a year earlier giving an indication of slowing manufacturing activity for the third consecutive month.

Respondent assessments appear mixed with some sounding a cautious tone while others remain more upbeat:


"Customers are anticipating resin price decreases and holding back orders." (Plastics & Rubber Products)
"Slight uptick in overall business but not substantial." (Textile Mills)

"Government spending has tightened, which has moved out program awards and caused some reduction in force." (Computer & Electronic Products)

"Market outlook is relatively flat, with some promise of raw materials inflation relaxing." (Electrical Equipment, Appliances & Components)

"General economy seems sluggish and pensive. Buyers are not buying much beyond lead times." (Fabricated Metal Products)

"Downturn in European and Chinese markets is having a negative effect on our business." (Machinery)

"We are having a difficult time hiring skilled employees." (Transportation Equipment)

"Business continues to increase, but over the past 20 days we have seen the trend flatten." (Furniture & Related Products)

"Market was holding strong until mid-month — then softened." (Wood Products)

"Decline in sales for FYQ2 over same period a year ago due to softer demand [in] both domestic and exports." (Chemical Products)

The Chicago Fed National Activity Index: January 2013

The latest release of the Chicago Federal Reserve National Activity Index (CFNAI) indicated a notable weakening for the national economy with the index falling to a very low growth level of -0.32 from a level of 0.25 in December while the three month moving average improved to a level of 0.30.

The CFNAI is a weighted average of 85 indicators of national economic activity collected into four overall categories of “production and income”, “employment, unemployment and income”, “personal consumption and housing” and “sales, orders and inventories”.

The Chicago Fed regards a value of zero for the total index as indicating that the national economy is expanding at its historical trend rate while a negative value indicates below average growth.

A value at or below -0.70 for the three month moving average of the national activity index (CFNAI-MA3) indicates that the national economy has either just entered or continues in recession.

Recession Watch 2013: Piger Probability Series

Last year I reported on a relatively new recession probability indicator (… the “markov switching” series recently introduced to the Fed FRED/Blytic) that was giving a pretty clear, though preliminary, indication of probable recession.

While I noted that the series was highly revised, I pointed out that even taking into account the revisions, the series was giving a recession signal since using just the "maximum" reported values (values that had been all been revised lower) the reporting 20% probability was very unusual and typically associated to oncoming trouble.

In the latest release, the November data (... there is a reporting lag) indicates that the probability of recession has declined to .22% while the standout August value (that initially peaked interest in this series) has now been revised to 1.7%.

It's important to note though that the point of my prior post was to highlight just the "maximum" reported values and while the latest release revises down August's 19.6% and reports an additional low probability for the latest month, it makes no difference... the fact remains that this series has NOT given such a significant over estimate of recession without there being a probable recession ahead.

Now clearly, there could always be a first time... this is just estimated data... but the prior 19.6% reported figure clearly argues for following this series very closely in the coming months.  

Recession Watch 2013: Term Spread Probability Series

With the weak economic recovery fast approaching its fourth continuous year of expansion, its sensible to start looking for clues, however so slight, of the possibility of oncoming recession.

First, let’s remember that while the NBER makes the official call of both the “peak” of a business cycle expansion and the “trough” of the subsequent recession, their officiating is delayed to say the least.

For a more “real time” assessment of the prospects of recession, various methods of number crunching have been formulated to distill out a basic probability assessment from several underlying macro series data sets.

One popular statistical method is the yield-curve based “Term Spread” probability method.


Spearheaded by economist Professor Arturo Estrella of the Rensselaer Polytechnic Institute, this method derives a probability of recession from the spread between long and short yields (10-year and 3-month) and is by all accounts the standard for recession probability forecasting.

The latest data indicates that the probability for recession is continuing to rise with a November 2013 probability (the probability that there will be a recession by that date) of 6.3%.

Keep in mind that a positive indication using this method would require this probability to reach 30% so while the probability is clearly rising, the current probability is still quite low.

Recession Watch 2013: Piger Probability Series

Last year I reported on a relatively new recession probability indicator (… the “markov switching” series recently introduced to the Fed FRED/Blytic) that was giving a pretty clear, though preliminary, indication of probable recession.

While I noted that the series was highly revised, I pointed out that even taking into account the revisions, the series was giving a recession signal since using just the "maximum" reported values (values that had been all been revised lower) the reporting 20% probability was very unusual and typically associated to oncoming trouble.

In the latest release, the October data (... there is a reporting lag) indicates that the probability of recession has risen to 7.34% while the standout August value (that initially peaked interest in this series) has now been revised to 4.46%.

It's important to note though that the point of my prior post was to highlight just the "maximum" reported values and while the latest release revises down August's 19.6% and reports an additional low probability for the latest month, it makes no difference... the fact remains that this series has NOT given such a significant over estimate of recession without there being a probable recession ahead.

Now clearly, there could always be a first time... this is just estimated data... but the prior 19.6% reported figure clearly argues for following this series very closely in the coming months.  

Recession 2013....Redux

Last month I reported on a relatively new recession probability indicator (… the “markov switching” series recently introduced to the Fed FRED/Blytic) that was giving a pretty clear, though preliminary, indication of probable recession.

While I noted that the series was highly revised, I pointed out that even taking into account the revisions, the series was giving a recession signal since using just the "maximum" reported values (values that had been all been revised lower) the reporting 20% probability was very unusual and typically associated to oncoming trouble.

In the latest release of the data we find that not only has the September (... there is a lag) value come in at a relatively low level of 2.94% probability of recession, the August number has now been revised down from 19.6% to 3.8%.

It's important to note though that the point of my prior post was to highlight just the "maximum" reported values and while the latest release revises down the 19.6% and reports an additional low probability for the latest month, it makes no difference... the fact remains that this series has NOT given such a significant over estimate of recession without there being a probable recession ahead.

Now clearly, there could always be a first time... this is just estimated data... but the prior 19.6% reported figure clearly argues for following this series very closely in the coming months.  

New Round of Downsizing Looming?

Looking deeper into last Friday’s weak industrial production report, it appears that the “Business Equipment” component is giving a clear sign of weakness as well as substantiating the business investment pullback noted over the weekend by the WSJ.

In fact, looking at the data (click on the chart below for a full-screen dynamic version of the entire history of this data series) it’s easy to see that this series makes fairly sharp tops as the economy transitions into recession making it a useful contraction indicator.

Keep in mind though, while the latest results look like another solid harbinger of looming recession, the data is still fairly preliminary and subject to revision.

Another couple or few months of data will be required to determine if this pullback is simply a slowing of our halfhearted recovery or a more notable slide into a new recessionary decline.

The European Domino

Yesterday, EuroStat, the European Union’s statistics office, released their Q3 2012 read on the 17-nation combine GDP showing a quarter-to-quarter decline of 0.1%, tipping the group squarely (though possibly temporarily due to future revisions) into recession, as economic conditions worsened and continued from the prior quarter’s -0.2% reading.

While recession for Europe is no surprise, given all the attention that has been directed to the crisis economies of Greece, Spain, Italy, and Portugal and the broader weakness elsewhere in the European Union, it should also be clear that the U.S. faces nearly identical prospects as the burdens of government overreach take their toll on macroeconomic conditions.

Further, while the U.S. generally prides itself on having more robust economic conditions than Europe, comparing the quarterly growth rates, one can easily see that for over a decade now, our economic conditions have, more or less, trended together.

So this begs the question, how long can the U.S. expect to buck the trend?

Unless you expect notable improvement in future quarters, it would appear that the European Union’s poor conditions are just another harbinger of larger global underperformance that could crush the U.S.’s tepid recovery.

Recession… a Real Probability

Last week I reported on a relatively new recession probability indicator (… the “markov switching” series recently introduced to the Fed FRED/Blytic) that was giving a pretty clear, though preliminary, indication of probable recession.

Since then, there has been quite a bit of scuttlebutt around the econo-blogesphere (here and here) about this series and the validity of its present value.

While I agree that this series’ nearly 20% indication of recession is VERY preliminary (as I noted in my original post), I would like to respectfully take issue with the analysis offered by some of the “debunkers” of this recession warning as well as add some further perspective on the series in general.

First, while Professors Chauvet and Piger suggested (in the original methodology paper) that a probability value at or above 80% for a period of three consecutive months was required for a positive indication of recession, I would like to point out that looking at the “minimum” and “maximum” extract of all reported values for this series indicates pretty clearly that the current 20% is not likely to be completely “revised away” as some would suggest.

Further, looking EXCLUSIVELY at the “maximum” reported values clearly shows that there is cause for concern in so much as NEVER has the “maximum” series indicated a value at or above 20% that a recession hasn’t followed within 6-8 months.

In order to determine the “minimum” and “maximum” series, I simply extracted the MIN and MAX values from every reported period (from Professor Piger’s complete history of this series) for this series thus creating two additional series, one containing all the lowest reported values for each period and one containing all the highest reported values (you can download my spreadsheet here).

Looking at the chart below (click for full-screen dynamic version) you can see the “minimum” reported probabilities in black, the “maximum” reported probabilities in red and the “actual” reported series in light blue (yellow bands are recessions).

Recession Watch: November 2012

While it is well know that “all good things must come to an end”, on “mediocre things”, we are totally in the dark, adrift without any wise or memorable turn of phrase to help lend a guide.

To that end, and given the current state of affairs, I think now is about as good a time as any to start directly tracking the probability of recession.

First, let’s remember that while the NBER makes the official call of both the “peak” of a business cycle expansion and the “trough” of the subsequent recession, their officiating is delayed to say the least.

For a more “real time” assessment of the prospects of recession, various methods of number crunching have been formulated to distill out a basic probability assessment from several underlying macro series data sets.

First, there is the popular yield-curve based “Term Spread” probability method.


Spearheaded by economist Professor Arturo Estrella of the Rensselaer Polytechnic Institute, this method derives a probability of recession from the spread between long and short yields (10-year and 3-month) and is by all accounts the standard for recession probability forecasting.

The latest data indicates that the probability for recession is starting to rise with a September 2013 probability (the probability that there will be a recession by that date) of 5.9%.

Keep in mind that a positive indication using this method would require this probability to reach 30% so while the probability is clearly rising, the current probability is still quite low.

In 2008, Marcelle Chauvet of the University of California and Jeremy Piger of the University of Oregon published a paper titled “A Comparison of the Real-Time Performance of Business Cycle Dating Methods” which outlined two novel statistical methods (most notably the markov-switching method) for distilling recessionary turning points out of the very same macro data series that the NBER uses to make it’s cycle assessments.


As of August (the latest data… there is a lag), the markov-switching method is indicating a 19.6% chance of recession, a notable finding to say the least.

In fact, a probability this high has positively indicated every recession since 1967, (the extent of this probability series) an ominous harbinger for sure, but before you head for the window, remember that this probability series is HIGHLY revised as a result of the revisions made to the underlying macro series.

As always, it will take more time to determine for sure whether the current mediocre “expansion” is drawing to a close, but looking at both of these sensitive indicators, one could clearly argue that the probability of that prospect is on the rise.

The Chicago Fed National Activity Index: September 2012

The latest release of the Chicago Federal Reserve National Activity Index (CFNAI) showed an improvement of the national economy with the index climbing from the prior month to stand at a very weak 0.00 while the three month moving average remained very near contraction territory at -0.37.

The CFNAI is a weighted average of 85 indicators of national economic activity collected into four overall categories of “production and income”, “employment, unemployment and income”, “personal consumption and housing” and “sales, orders and inventories”.

The Chicago Fed regards a value of zero for the total index as indicating that the national economy is expanding at its historical trend rate while a negative value indicates below average growth.

A value at or below -0.70 for the three month moving average of the national activity index (CFNAI-MA3) indicates that the national economy has either just entered or continues in recession.