Does September’s fall in the Philly Fed Survey mean the US economy is heading for recession?

Had investors been focussing on the future activity index, perhaps the reaction might have been even greater, with the index falling to its lowest level (-0.2) since January 2001, when the economy really was in recession. However, whilst the response from investors, which saw 10-year Treasury bond yields falling to a six month low of 4.6% and the dollar coming under renewed pressure, was understandable as traders contemplated the prospect of lower interest rates in 2007, we would caution against reading too much into one month’s figures. In particular, the data are notoriously volatile on a month-by-month basis, with the indicator having been at a comparatively low +6 in July before jumping in August. For this reason, we prefer to focus on the three-month moving average. On this basis, as the chart shows, whilst the indicator has moved lower over the last few months it has done so only very modestly and importantly remains above the levels seen at the end of last year. But more important still, again as the chart illustrates, whilst the fit between the survey and economic growth is extremely close, historically a zero reading has generally been associated with year-on-year GDP growth of around 2½-3% - it certainly hasn’t corresponded with outright declines in the level of GDP. Indeed, for this to happen arguably we would need to see the index falling below -20, as was the case at the beginning of the decade and before that in the early 1990s. Once again, the downside risks to the real economy would appear to have been exaggerated. The US economy is slowing, but only onto a more sustainable growth path. Talk of recession in 2007 is far too gloomy.

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