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An Uptick in Our Economic Model

AIER’s Leading Indicators model rebounded in May to the neutral level of 50, following two months at 38, which had indicated a somewhat higher risk of recession. This uptick supports our expectation that we will see a resilient labor market boost consumer sentiment and spur further gains in consumer spending. AIER researchers now judge the risk of recession has receded, although it is still slightly elevated.

Our model, published today in the June edition of Business Conditions Monthly, is based on data available through the end of May.

Our Leaders index consists of 12 separate indicators, of which five changed signals in the latest month. Of the five changes among the Leaders, four improved in the latest month, while one worsened. The four trending higher were: real new orders for consumer goods, the average workweek in manufacturing, real retail sales, and the Treasury-yield spread. Initial claims for unemployment insurance turned from positive to neutral.

Among the four Leaders that are trending higher, two are consumer-related: real retail sales and real new orders for consumer goods. Favorable trends in these two indicators are particularly reassuring, as consumers represent about two-thirds of the overall economy. Together, they suggest that a virtuous cycle of spending gains leading to higher production could result in additional hiring, faster income growth, and subsequent future gains in consumer spending.

Among the remaining indicators, four continued to trend lower, while four were neutral.

With the year’s midpoint approaching, we look ahead to the second half of 2016. Analysts and investors are likely to vacillate between two narratives that seem to be mutually exclusive: weakness and strength. In a slow-growth environment, periods of weakness are likely to renew  fears of recession, while spurts of strength should rekindle debate about rising price pressures, a less accommodative Federal Reserve policy, a tightening labor market, and rising wages. These two narratives will be debated within the context of the election season.

We believe four key items will be particularly important in determining the strength of growth in the second half of the year, and we will watch them closely: the Fed, the dollar, oil prices, and corporate profits. You can read more about these factors in the new edition of Business Conditions Monthly.

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