A Framework That Provides Clarity

During periods of “low visibility,” confusion reigns: for every indication of one trend, there seems to be a countertrend. The key is to glean from the collective wisdom of reliable leading indicators a clear signal that the economy is headed for a turn.



A Chill Wind

With the Fed set to push up interest rates for the first time in over four years today, one little fact may have eluded many investors: The economy's growth rate already seems to be slowing down.

Start with consumer spending. When the Commerce Department released May spending figures Monday, it revised down its read on real personal consumption in April. This came hand in hand with warnings of slower June sales from General Motors, Wal-Mart Stores and Target, which account for about one-tenth of U.S. retail sales.

In the wake of the surprisingly strong consumer-confidence reading yesterday, some may see this as a mere blip. But there is further evidence of sluggishness. Tucked inside of last week's generally dismal May durable-goods report were unexpected declines in capital-equipment shipments and orders.

Add cooler consumer and business spending together, and a slower economy results. Last month, economists surveyed by had second-quarter gross domestic product growth pegged at an annualized 4.6%. Now, a growth rate with a "three" in front of it seems more reasonable, says Citigroup economist Christopher Wiegand. Merrill's David Rosenberg suggests 2.5% is possible.

All this comes on top of Friday's final read on first-quarter GDP, which put growth at 3.9% rather than the previously reported 4.4%. Those are still relatively strong growth numbers, but the breathless pace of last year seems long ago.

The Weekly Leading Index, an amalgamation of economic indicators -- plus some math -- put together by the Economic Cycle Research Institute, has slipped substantially over the past three months. Given the index's forecasting history, this bears notice -- a sharp drop in 2000 had ECRI's economists forecasting a grimmer economic downturn than the garden-variety slowdown that others had expected.

ECRI also does work on where inflation is headed, and here is where it gets interesting. Even as the economy looks set to further cool, inflation looks as though it could keep heating up.

Maybe inflation just needs a little time since it's supposed to lag behind growth. Emphasis on supposed to. Inflation cycles and economic cycles are distinct, says ECRI research director Anirvan Banerji. And they can unlink -- as in the late '70s when inflation was white-hot and the economy was stone-cold (stagflation) and again in the '90s when inflation was muted and growth was strong (Nirvana).

The upshot is slowing growth may not be enough to push the Fed to the sidelines. For investors, that isn't a pleasant prospect.