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Mind the business cycle, part 2

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Publish Date: 
Friday, February 26, 2016 - 2:15:00 PM MST

Counter-intuitively, the recent increases in core inflation are normal in the sequence of how a recession evolves. The typical business-cycle sequence is that the manufacturing sector weakens first, then employment and consumer spending, and lastly, inflation. In fact, it is often not until the recession is over that inflation begins to come down. Inflation is the longest lagging indicator.

As recently as 2008, the FOMC’s hawks exploited this phenomena to argue for rate hikes (or actually raise rates in the ECB’s case), all while the economy was crumbling underneath. We covered that period here. Those desperate for any bullish signs will certainly do the same now, but using current inflation to argue for rate hikes or the avoidance of a downturn is misplaced.

As we have pointed out here and here, manufacturing has clearly turned down in a way (3 independent indicators) that has not failed in calling an upcoming recession. We think that we have entered or will soon enter a full blown US recession. Don’t be led astray by late-cycle rises in core inflation.