Don't believe the talk about the end of the slowdown
I am quite sceptical that the strong first quarter GDP growth data released on Friday really is a signal of a turnaround in the US economy. As I have mentioned above, the positive surprise was driven by rising inventory levels and international trade, two of the more volatile components of GDP. Household consumption rose only 1.2% in the first quarter and fixed investments rose 1.5%. And this is where a turnaround would have to come from if it were sustainable. Instead, it looks like fixed investments and industrial production are bound to slow even more.
One of the lesser-known leading indicators of the US economy is the Chemical Activity Barometer (CAB) of the American Chemistry Council. Published monthly, it combines production data of a range of chemicals with other relevant data such as hours worked in the industry, sales-to-inventory ratios, inventory levels and price data for industrial chemicals. The great thing about this indicator is that is goes back to 1913 and leads business cycle peaks by about eight months and business cycle troughs by about three months.
I checked this claim and found that the CAB predicts the onset of a recession about eight to nine months in advance with a hit ratio of about 83%. Also, the CAB has a lead of about three months over the broader industrial production data and a Granger causality test shows that the CAB causally influences the industrial production data (Can you tell that I recently got professional econometrics software so now I can do some proper analysis?).
The reason why the CAB leads overall industrial production is because it uses inventory data and other data that has a leading relationship to the actual output. Furthermore, the chemical industry in the US is more export-oriented than the overall industrial sector, so that the activity in this industry picks up on slowing and accelerating global growth more quickly than industrial production.
Our chart shows the annual change in the CAB together with the annual growth rate of US industrial production and US recessions. Most of the time, the CAB and US industrial production move together with the CAB leading by about three months, as we said. However, there are some exceptions to the rule, such as in 2004 when the CAB rose much more than US industrial production as China’s economic growth took off, and with it the demand for US chemicals. Similarly, in 2011 and 2012, the CAB declined more than US industrial production because of the recession in Europe that reduced demand for chemicals in that region.
Since September 2018, the CAB has again started to decline more rapidly than overall US industrial production. The annual growth rate of the CAB declined from 4.4% in September to 1.0% in April, while industrial production growth declined only from 4.9% to 3.3%. Given the historical relationship between the CAB and the broader US economy we should expect US industrial production growth to slow down more throughout the second quarter and US growth to continue its slowdown in the second and third quarter. The CAB does not yet indicate any recession on the horizon, with a probability of the US being in recession today at only 20% or so, but if the current decline continues in coming months, things might change quickly.
US Chemical Activity Barometer and industrial production
Source: American Chemistry Council, Fidante Capital.