In most discussions, the economy is portrayed as existing in only two states – most often termed “growth” and “recession”.
The National Bureau of Economic Research (NBER)’s authoritative Business Cycle Dating Committee itself uses a two-part classification – “expansion” and “contraction”.
This binary approach encourages economists, investment analysts, journalists and politicians to produce endless forecasts about whether the economy will enter a recession or avoid one.
But it is an unhelpful oversimplification that glosses over many different states of the economy and their impact on output, incomes, employment, investment, interest rates and energy consumption.
In reality, the business cycle is a continuum ranging from boom, rapid recovery and strong growth at one extreme through soft patches and mild recessions to severe recessions and depressions at the other.
Explaining its interest rate decisions, the U.S. Federal Reserve has characterised economic activity with phrases including “rapid”, “vigorous”, “robust”, “solid”, “moderate”, “slowed considerably” and “severe disruption”.
Growth in business activity tends to accelerate and decelerate; outright declines in the level of activity are relatively rare.
UNDECLARED RECESSIONS
The NBER’s Business Cycle Dating Committee formally declared only six recessions between 1980 and the end of 2020.
The U.S. economy was in recession for just 58 out of 492 months (less than 12% of the time), on the NBER definition.
But there have been twice as many distinct cyclical troughs in the purchasing managers’ manufacturing index published by the Institute for Supply Management (ISM) over the same 41-year period.
These additional cyclical troughs centred on 1985, 1989, 1996, 1998, 2012 and 2016 were never formally declared as recessions by the NBER.
In the Fed’s discussions, these periods were characterised as periods of “moderate growth” or a “soft patch”.
They were periods of little or no growth in an otherwise uninterrupted business cycle expansion and tend to be forgotten.
But at the time these mid-cycle slowdowns or undeclared recessions often felt almost as painful for businesses and households as formally declared recessions.
Dissatisfaction with sluggish wage growth resulting from mid-cycle slowdowns in 2012 and especially 2016 likely contributed to the election of President Donald Trump in 2016.
Mid-cycle slowdowns also reset the economy by easing capacity constraints and relieving upward pressure on prices and wages.
The unusually long business cycle expansions of the 1980s (92 months), 1990s (120 months) and 2010s (128 months) were each punctuated by two mid-cycle slowdowns.
Mid-cycle slowdowns almost certainly helped prolong the formally declared expansions by freeing up spare capacity and taking some of the heat out of prices and wages.
If it hadn’t been for mid-cycle slowdowns in 1996 and 1998 during the long boom of the 1990s, the U.S. economy would almost certainly have run into capacity constraints and a recession before 2001.
Similarly, if it hadn’t been for mid-cycle slowdowns in 2012 and 2016, resetting capacity utilisation and sapping inflation and wage growth, it seems likely the most recent expansion would have ended before 2020.
From an analytical viewpoint, the distinction between mid-cycle slowdowns that prolong an expansion and cycle-ending recessions is somewhat arbitrary, a difference of degree rather than nature.
For that reason, it is more useful to focus on whether the growth in business activity is accelerating or decelerating rather than whether the economy is in recession or not.
SLOWDOWN HAS BEGUN
U.S. manufacturers reported activity was broadly flat in October as the merchandise and freight sector of the economy continued to lose momentum in the face of rapid inflation and excess inventories.
The ISM purchasing managers’ index slipped to 50.2 in October (30th percentile for all months since 1980) from 50.9 in September (36th percentile) and 60.8 a year ago (99th percentile).
The composite index has declined in nine of the last 12 months and is now at the lowest level since May 2020, when the economy was still in the grip of the first wave of the coronavirus epidemic.
The new orders component was below the 50-point threshold dividing expanding activity from a contraction for the fourth time in five months (“ISM manufacturing report on business”, Nov. 1).
More businesses reported new orders were lower (25%) than higher (18%) likely heralding a further slowdown in the months ahead.
Slower growth in manufacturing and freight is translating into slower growth in the consumption of diesel and other middle distillates.
The volume of distillate fuel oil supplied to the U.S. domestic market (a proxy for consumption) was up by less than 1% in the three months from June to August compared with the same period in 2021.
Distillate use is closely correlated with the ISM index so the continued decline in the index in September and October signals consumption growth likely slowed further.
CYCLICAL SLOWDOWN
Between 1980 and the end of 2020, the ISM manufacturing cycle reached a distinct trough on average every 41 months or roughly every 3-4 years.
The current cyclical manufacturing upturn dates from April 2020 and is 30 months old; manufacturing activity accelerated through late 2020 and into 2021 but has been losing momentum since late 2021.
The manufacturing and freight cycle, rather than formal recessions alone, is what matters for the consumption of distillate fuel oil and other cyclical energy products.
The current downturn in the manufacturing cycle will dampen the rate of growth in distillate consumption and possibly even reduce fuel use outright.
In the United Kingdom, the European Union and China the cycle appears even more advanced, with purchasing managers’ surveys indicating activity is already falling in each case.
The Eurozone manufacturing purchasing managers’ index slipped to 46.4 in October (12th percentile for all months since 2006) and has been below 50 for four months running.
China’s manufacturing index slipped to 49.2 (4th percentile for all months 2011) and has been below 50 in six of the last eight months.
The slowdown will ripple out from the major economies at the core of the global economy (the United States, China and Europe) to the lower-value manufacturers and commodity producers on the periphery.
The cyclical slowdown will reset industrial capacity utilisation, labour markets, inflation and wage growth – whether or not it results in a formal recession being declared.
