Key facts
- A new measure of financial conditions suggests the US economy is headed for weakness.
- The gauge combines economic policies and forces, with seven of eight indicators showing contractionary signals.
- Rising long-term and short-term Treasury yields, a flattening yield curve, and falling net deficit spending are key signals.
- Higher oil prices and accelerating core inflation also contribute to the restrictive outlook.
- Real wages have fallen, indicating a decline in purchasing power.
- Historically, the gauge's rise to its current level has preceded major US recessions.
Jim Paulsen, a veteran Wall Street strategist, has developed a new gauge of financial conditions that indicates the US economy is likely to experience a period of weakness. The gauge, which measures five economic policies and three economic forces, has historically been a leading indicator of economic growth and stock prices since 1970.
Paulsen's analysis highlights seven contractionary forces acting on the economy. These include rising long-term and short-term Treasury yields, with the 10-year yield reaching a post-Financial Crisis peak of 5.09% and the 2-year yield hitting a two-year high of 4.89%. The yield curve has flattened, suggesting market expectations for higher short-term rates. Additionally, fiscal support is perceived to be fading, as the US federal budget deficit for the first 11 months of fiscal year 2026 is estimated to be $2 trillion, a decrease of $6 billion from the previous year.
Other contractionary signals include higher oil prices, with Brent crude trading around $101 a barrel, and accelerating inflation, as core CPI rose 0.3% last month. Real wages have also fallen, declining 0.1% in August after accounting for inflation, according to the Bureau of Labor Statistics.
The gauge is currently in its topmost quartile, a level that has historically preceded every major US recession. Paulsen expressed skepticism about further Federal Reserve rate hikes, suggesting it might be a mistake given the tightening financial conditions. He anticipates weaker economic growth, increased recession fears, lower bond yields, and a more challenging stock market environment in the coming months.