Near-Term Growth Prospects Remain Challenging

Our dashboard of leading indicators through mid-January suggests that the U.S. economy is still decelerating, mostly because of tighter monetary policy and a slowing global economy. In November, eight of the 10 leading U.S. indicators we track sent negative (seven) or neutral (one) signals for near-term economic growth prospects, and none of the indicators that have available December data changed its signal. (December data on the Freight Transportation Services Index is pending at the time of this report.)

Weak consumer sentiment in the face of rising interest rates and surging inflation is contributing to a higher risk of recession in the U.S. over the next 12 months. However, gas prices have started to decline recently, helping to lift consumers' moods from their low in June.

Where Do We Stand? A Comparison With Past Business Cycles

Eight of the 10 indicators (80%) in November flashed either negative or neutral signals (see chart 1). This has now occurred in each of the last five months for which we have complete data. Seven of the 10 indicators we track gave negative signals in November. Historically (going back to 1980), when over 50% of the indicators we track were negative, a recession followed within 12 months. We continue to expect a shallow and short recession for the U.S. economy in 2023.

Chart 1

Yields and quantitative risk of recession

The term spread we use in our dashboard--the difference between the 10-year and three-month Treasury yields--is flashing a negative signal. It has been inverted since November and ended December at -0.75% (see chart 3). Intermediate spreads--the 10-year/two-year and the 10-year/one-year--have been inverted since July. The 10-year/two-year spread moderated to -0.52% in December from -0.72% in November, and the 10-year/one-year edged up to a slightly less inverted -0.90% in December from -1.03% in November.

Most spread models are now pricing in a recession 12 months out. In December, our quantitative assessment of recession risk, based on a spread risks model, gave a 52% probability of a recession in the next 12 months when using the 10-year/three-month spread. The 10-year/two-year spread implies a 44% probability of a recession in the next 12 months, and the 10-year/one-year spread implies a 51% probability (see chart 2). As of Jan. 9, the odds of a recession using the 10-year/three-month term spread have moved higher, to 59%.

Chart 2

Corporate credit spreads, S&P 500, and consumer sentiment

The S&P 500 index has fallen 19% from its Jan. 3, 2022, peak while high inflation and a hawkish Federal Reserve made it hard for investors to gain confidence in the market. Corporate credit spreads are widening as rising interest rates undermine growth prospects. On our dashboard, the S&P 500 flashed negative signals for 10 months last year, while credit spreads gave a neutral signal for 10 months in a row.

The University of Michigan Consumer Sentiment Index rose to 59.7 in December from 56.8 in November but is still below its six-month peak of 59.9 in October. Notably, the jump in sentiment from its record low in June has come on the back of an improved one-year economic outlook and falling inflation expectations (see chart 4). The consumer-sentiment signal on our dashboard flashed negative in 10 months last year.

The preliminary sentiment reading for January was surprisingly high, fueled by lower gas prices, raising hopes that consumer sentiment could soon flash neutral on our dashboard. The one-year inflation expectations gauge slid to 4.0% in January from 4.4% in December and is down from the 41-year high that spooked the Fed in March and April. The 5-to-10-year inflation expectations reading edged up to 3.0% from 2.9% in December and stayed close to its 11-year peak of 3.1%, seen both in June and last January. Although inflation expectations have come down, they're still twice what the Fed would like to see, indicating its job is not complete.

Building permits and New Orders Index

The housing market cooled further throughout the second half of last year as mortgage rates climbed; the 30-year fixed rate hit 6.46% on Jan. 13, still below its peak of 7.24% on Nov. 11. The Mortgage Bankers Assn.'s purchase index, which plummeted to an eight-year low in October, has rebounded modestly since then, gaining 5.4% in November and another 2.1% in December. We expect the Fed's aggressive rate hikes to continue until at least the middle of this year, keeping housing demand weak until then.

The Institute for Supply Management's New Orders Index for manufacturers has been declining for the past four months, a sign that weakness in manufacturing activity will persist. The index fell to 45.2% in December, the lowest reading since the start of the pandemic. If we exclude the pandemic-led distortion of new orders, the December print was the weakest since the great financial crisis (see chart 6). The survey also showed that demand was still soft in 11 of the 18 industries it follows, such as wood products; nonmetallic mineral products; fabricated metal products; food, beverage, and tobacco products; chemical products; and furniture and related products.

The institute's New Orders Index for services, which we don't include in our dashboard, also fell in December--to 45.2%, the lowest reading since May 2020. The overall services index unexpectedly fell, to 49.5--contraction territory and a May 2020 low. Prices remained robust at 67.6%, highlighting the sticky prices the Fed must grapple with in the sector.

Credit availability indicators

Banks have further tightened lending standards across all loan categories because of deteriorating market conditions, per the Senior Loan Officer Opinion Survey (see chart 7). Lenders believe high inflation will strain borrowers' debt-servicing capacity, increasing lenders' exposure to risk.

The Chicago Fed's National Financial Conditions Index (NFCI) fell by 12 basis points over the past month, signaling slight improvement in market liquidity (see chart 8). The Fed's aggressive rate hikes over the last nine months, however, have limited credit availability. There are other mixed signals: A drop in the NFCI Leverage Sub-Index in December could lead the market to believe that the Fed might slow its rate hikes, while negative real interest rates suggest that the financial market may still be too loose for the Fed's liking.

Real-time economic conditions

The labor market is still strong despite signs of a slowing economy overall. Jobless claims adjusted for the labor force, which respond rapidly to changing business conditions, are still flashing a positive signal in our dashboard. The annual growth rate of the Freight Transportation Services Index, which is released with a lag, is also in positive territory through July.

Chart 3

Chart 4

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Chart 6

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Chart 8

Appendix

Definitions of positive/neutral/negative signals

• Positive: Overall economic activity will continue to expand in the near term, without an obvious slowdown.
• Neutral: Overall economic activity will continue to expand but may be slower. Right after a recession, a neutral signal indicates that the recovery may have just started.
• Negative: Overall economic activities will start to contract shortly afterward, roughly within a year.

The views expressed here are the independent opinions of S&P Global Ratings' economics group, which is separate from but provides forecasts and other input to S&P Global Ratings' analysts. S&P Global Ratings' analysts use these views in determining and assigning credit ratings in ratings committees, which exercise analytical judgment in accordance with S&P Global Ratings' publicly available methodologies.