The Nonfinancial leverage subindex of the National Financial Conditions Index increased slightly (less good) this week but still remains well inside of economic expansion territory. Econintersect focuses on non-financial tools to monitor the economy.
This index remains on a “less good” trend line, and is believed to be a good forward indicator a recession is coming. A value above zero is a recession warning.
If the trend continues at the current rate of deterioration, a recession is more than two years away.
According to the Chicago Fed:
The NFCI edged up to —0.76 in the week ending August 30, but continued to indicate looser-than-average financial conditions. The risk and credit subindexes increased slightly, while the leverage and nonfinancial leverage subindexes were unchanged. [editors note: this statement is wrong – see table below.]
The ANFCI also edged up in the week ending August 30, increasing to 0.18. This level of the ANFCI indicates that financial conditions are slightly tighter than would typically be suggested by current economic conditions. July data on total PCE inflation and the Chicago Fed National Activity Index led to an average upward revision of 0.15 standard deviations to recent weeks’ values of the ANFCI.
The Chicago Fed has continuous backward revision to the data:
|Date||Value Last Week||Value this Week|
The dotted line on the graph below is the Nonfinancial Leverage NFCI, and is being used as a recession monitoring tool. When the Nonfinancial Leverage NFCI goes above 0, it is a recession warning. This index isolates a component of financial conditions uncorrelated with economic conditions to provide an update on financial conditions relative to current economic conditions.
According to the Chicago Fed:
The nonfinancial leverage subindex of the NFCI best exemplifies how leverage can serve as an early warning signal for financial stress and its potential impact on economic growth. The positive weight assigned to both the household and nonfinancial business leverage measures in this NFCI subindex make it characteristic of the feedback process between the financial and nonfinancial sectors of the economy often referred to as the “financial accelerator.” Increasingly tighter financial conditions are associated with rising risk premiums and declining asset values. The net worth of households and nonfinancial firms is, thus, reduced at the same time that credit tightens. This leads to a period of deleveraging (i.e., debt reduction) across the financial and nonfinancial sectors of the economy and ultimately to lower economic activity.
The solid black line [on the above chart] is the nonfinancial leverage subindex of the Chicago Fed’s National Financial Conditions Index, and the solid blue line is the ratio of private credit to gross domestic product (GDP) detrended. For ease of comparison, both measures have been scaled to have a mean of zero and a standard deviation of one over the period 1973–2012.
The horizontal (time) axis is measured in weeks. We assign the quarterly private-credit-to-GDP ratio to the last week of each quarter to be able to plot it on the same figure panel as the weekly nonfinancial leverage subindex. The shaded regions in panel A correspond with historical periods of financial stress based on the analysis in Brave and Butters (2012). The shaded regions in panel B correspond with U.S. recessions as defined on a quarterly basis by the National Bureau of Economic Research. The dashed black line is the two-year-ahead prediction threshold for a financial crisis (panel A) and a recession (panel B) calculated for the nonfinancial leverage subindex, as explained in the text.
The Chicago Fed Letter Concludes:
Our nonfinancial leverage indicator signals both the onset and duration of financial crises and their accompanying recessions more reliably at longer lead times than the private-credit-to-GDP ratio.
source: Chicago Fed