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An analysis by Ataman Ozyildirim,
Senior Director, Economics
Click on the
chart to enlarge
The Conference Board Leading Economic
Index® for the US (LEI) declined for a fifth consecutive month
in July, suggesting recession risks are elevated in the near term (see
the latest press release here). The weakness in the index has been
widespread among its drivers and persistent throughout the first half
of 2022. Since the index reached its historically highest level in
December 2021, consumer pessimism, equity market volatility, housing
construction, and manufacturing worsened, and labor markets have
moderated. Along with the substantial drop in the LEI, its diffusion
index (measuring the proportion of components rising) has remained below
50 percent in the last four months through July—marking contractionary
territory. Based on preliminary data so far, the LEI is essentially
signaling that the US economy is on the cusp of a recession.
The LEI is used as a barometer of future economic conditions and a
forecasting tool because it is systematic, objective, and reliable.
Importantly, it points to changing conditions in the economic cycle.
While there are various ways to interpret the LEI in real time, a
reliable rule of thumb looks at the duration, depth, and diffusion—the 3D’s—of
a downward movement in the index. This rule now appears to be at or
near a recession signal. Duration refers to how long-lasting a decline
in the index is, and depth denotes how large the decline is. Duration
and depth are measured by the rate of change of the index over the last
six months. Diffusion is a measure of how widespread the decline is
(i.e., the proportion of index components that are falling below 50
when a majority of the components are deteriorating). The 3 D’s rule
provides signals of impending recessions when two criteria are
satisfied: (1) The rule requires that a majority of the 10 LEI
components are in contraction territory (black dotted line in the
chart), and (2) the magnitude of the decline over six months should be
below the median, -4.0 percent, annualized (red dotted line). If both
criteria are met simultaneously, the LEI signals a recession.
For more information on the most recent Leading Economic Index, please visit our website.
For The Conference Board’s most recent outlook, please see US economic forecast.
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