Breaking Down The Current Business Cycle | Eric Basmajian

Episode Summary

Executive Summary: The episode examines the U.S. business cycle through Eric Basmajan’s leading/cyclical/aggregate/lagging framework. He argues the cycle is normal but unusually delayed because post-COVID backlogs masked tightening effects in housing and manufacturing. Leading indicators have weakened for two years, cyclical sectors are only now contracting mildly, and aggregate/lagging data remain stable, helping explain resilient GDP, labor markets, and asset prices despite restrictive policy.

Main Topics: Business cycle framework and data sequencing (Priority: 5/5): Eric explains his four-bucket model: leading, cyclical, aggregate, and lagging. He argues economic data should be interpreted by sequence, not as a single blended signal, because different sectors respond at different points in the cycle. Why this cycle has been unusually delayed (Priority: 5/5): The conversation focuses on why rate hikes did not trigger an earlier recession. Eric attributes the delay mainly to unusually large production backlogs in construction and manufacturing, especially autos and housing, which extended the lag between leading weakness and cyclical contraction. Housing as the key cyclical transmission channel (Priority: 5/5): Eric emphasizes that housing is the business cycle only when defined as residential construction, not home prices. He explains how depressed transaction volumes eventually hit builders, then employment, then broader consumption and recession risk. Labor market conditions and jobless claims (Priority: 4/5): The hosts discuss mixed labor data, including unemployment, claims, and payroll revisions. Eric argues the labor market is weakening but not yet in a true layoff phase, largely because construction and manufacturing job losses remain mild and claims are still muted. Payroll revisions and the quality of headline jobs data (Priority: 4/5): Eric says nonfarm payroll revisions tend to follow economic momentum and are not nefarious; because the labor market has cooled, initial payroll prints have repeatedly been revised lower. He recommends mentally haircutting headline prints while using broader composites. Monetary policy, restrictive stance, and r-star (Priority: 5/5): The discussion closes with whether policy is still restrictive and whether cuts risk reigniting inflation. Eric argues rates remain restrictive, though less so than before, because money growth, the yield curve, bank lending, and housing volumes still look weak.

Key Arguments: Business cycles should be read as a sequence: leading indicators weaken first, then cyclical sectors, then aggregate output, then lagging/service-sector data. The current cycle is normal in structure but abnormal in timing because backlogs delayed the pass-through of higher interest rates. Manufacturing and residential construction are the key interest-rate-sensitive sectors that transmit tightening to the rest of the economy. The auto sector did not “power through” rates because it was still working through backlog demand created during stimulus and zero-rate conditions. GDP has stayed strong because aggregate measures are supported by consumption, inventory swings, and government spending, even while cyclical sectors soften. Labor market weakness is real but still early-stage; the economy has not yet seen enough construction/manufacturing layoffs to trigger a full recessionary labor contraction. Jobless claims remain muted mainly because the sectors that typically generate claims have not yet entered large-scale layoff mode. Payroll revisions usually align with economic momentum; as momentum cools, downward revisions are expected and should be mentally adjusted for. The unemployment rate contains noise from both labor supply and labor demand, so it should be read alongside broader employment indicators rather than in isolation. The Fed is still restrictive because the yield curve remains inverted, money supply growth is below trend, and housing transactions are deeply depressed. Rate cuts are not immediately likely to reaccelerate inflation because the leading and cyclical sectors that normally drive inflation are still weakening, not strengthening.

Data Points: Leading indicators growth: contracting for the last 24 months - Conference Board LEI used as the leading bucket in Eric’s framework Cyclical economy growth: from 4% two years ago to ~1%, then 0%, now mild contraction - Construction and manufacturing bucket is the engine of recessions Aggregate economy growth: ~1.5% (earlier slide showed 1.4%) - Composite of NBER-related variables Big Four aggregate growth: ~1.8% - Alternative aggregate measure excluding household employment and retail sales Lagging economy growth: stable and above trend - Service-sector-oriented lagging bucket Nonfarm payrolls growth: ~1.5% - One of the six NBER variables in the aggregate index Household employment growth: ~0.6% - Weak component of the aggregate labor picture Personal income growth: ~2.5% - Supports aggregate GDP strength Personal consumption growth: high 2% range - Main reason GDP prints remain firm Retail sales growth: weaker than consumption and income - Tilted toward goods economy Industrial production: mild contraction - Weakest of the aggregate components Motor vehicle sector growth: 5.5% to 0% - Example of a highly interest-rate-sensitive sector after tightening Motor vehicle sector growth six months ago: 4.4% - Shows delayed pass-through of rate hikes Residential construction inventory completed share in 2022: 8% completed / 92% under construction or not yet started - Evidence of extreme backlog in homebuilding Historical completed inventory share: about 30% - Normal composition of new home inventory Current completed inventory share: about 24% - Moving back toward historical norms Unemployment rate peak discussed: 4.3% - When the coincident employment index reached its weakest point Coincident employment index trough: -0.1% - Temporary contraction during labor market weakening Current coincident employment index: ~0.5% - Still positive but below trend Trend growth for coincident employment index: ~1.5% - Benchmark used to judge labor market health Latest three-month payroll average: around 150k - Used to illustrate slowing labor demand Jobless claims trend: very gradual rise from a low level - Muted because layoffs in construction/manufacturing remain limited Money supply growth: ~1% to 2% nominal - Below pre-COVID ~6% pace, indicating restrictive conditions Pre-COVID money supply growth: ~6% per year - Reference point for normal nominal growth GDP in 2022 recession scare: two negative quarters revised higher - Illustrates how inventory effects distorted the recession narrative Federal Reserve rate cuts mentioned: 75 bps total by year-end (hypothetical discussion) - Raised as a test of whether cuts could occur without reigniting inflation

Pivotal Quotes: "I like to sequence or separate the data into four major buckets, what I call leading, cyclical, aggregate, and lagging." — Eric Basmajan: Defines his core business-cycle framework "I believe that the auto sector... accumulated such a high level of backlogs in 2021 and 2022... it really took several years to work off the backlog." — Eric Basmajan: Explains why higher rates took so long to bite "I still don't think that we've had sufficient evidence to say, well, it's been two years since the Fed raised rates and nothing happens." — Eric Basmajan: Argues policy remains restrictive and the lag is not evidence of a higher neutral rate

Implications: Listeners should expect a slower but still unfolding cyclical downturn, with housing/manufacturing weakness likely to spread to labor and broader demand before a full recession appears. For markets, stable aggregate data may persist near-term even as the underlying cycle deteriorates.