The economic recovery is poised to not only continue but accelerate, according to the Conference Board’s Index of Leading Economic Indicators. The index is a compendium of ten factors that in the past have had a good history of predicting the direction of the overall economy over the next three to six months. These include things like stock prices, the yield curve (the difference between the yield on the 10-year T-note and Fed Funds), the growth of the money supply (M@) adjusted for inflation, the length of the manufacturing workweek, building permits, and consumer sentiment.

The index rose 1.4% in March, well above the 1.1% consensus expectations. It is also a significant acceleration from both February (up 0.4%) and January (up 0.6%). Both the February and January numbers were revised higher as well, from 0.1% and 0.4%, respectively.

Seven of the 10 indicators rose and three fell. The biggest positive contributors to the index in March were the yield curve, which reached its steepest level ever, and the manufacturing workweek. I would point out that the increase in long-term rates was driven by an increase in real interest rates — not by an increase in inflation expectations — as there was not a big jump in the difference between the regular 10-year T-note and the 10-year TIPS (inflation indexed treasuries) yields.

The steep yield curve has been a godsend to the banks (well, maybe God was not as responsible for it as the Federal Reserve, but the latter often confuses itself with the former) and is a big reason that even Citigroup (C) was able to report a profit in the first quarter. I still have major questions about the quality of the earnings at it and other major banks such as Bank of America (BAC) and Wells Fargo (WFC), but those relate more to the accuracy of their balance sheets, not from the huge net interest margins they are earning due to the steep yield curve. These earnings, combined with very low dividend payouts have allowed the banks to replenish their capital and to become solvent once again.

An increase in the manufacturing workweek usually happens before employers hire more people full time. An intermediate step is often calling up a firm like Manpower (MAN) to hire temporary workers. Temporary workers have been one of the strongest areas of employment so far in 2010, with 126,000 temp jobs added so far this year.

Vendor performance was the third largest contributor, followed by stock prices and building permits. Since stock prices are one of the leading indicators, people should keep that in mind if they use the leading index to become more bullish on the market when it rises (or more bearish when it falls) as one can easily fall into circular logic. However, it was not the main factor behind the rise in March, so I wouldn’t be too worried about that right now.

The first of the three factors which detracted from the index was the real money supply, which has been down in two of the last three months, and is mostly a reflection of banks’ hesitancy to make loans. The weak money supply growth also means that there is not likely to be a lot of inflation coming in the near- to intermediate-term future.

Orders for non-defense capital goods was also weak, and a bit of a surprise that they were weak, but they were not headed off a cliff and just edged down slightly after adding to the index in the previous three months. The consumer expectations component declined for the second month in a row, and for the third time in the last five months.

The increase in the leading indicators is good news, meaning that the recovery is probably sustainable after the government training wheels come off. I would, however, note that we still have a very soft economy and economic stimulus is still needed, particularly in the form of very low interest rates from the Fed. Inflation is not a problem we should be worrying about right now.

The problem is that we have 9.7% of the workforce unemployed, and 44% of the unemployed have been out of work for more than six months. Only 70% of our manufacturing capacity is being used (about 80% is normal). The total demand in the economy is well below its potential level.

Getting the economy moving again will also do wonders to alleviate the longer-term economic problem we have in the form of high deficits and government debt levels. A stronger economy will generate more tax revenues and will lead to reduced spending on palliative programs, like extended unemployment benefits and food stamps.

A growing economy will also help to bring down the ratio of debt to GDP, even if we don’t actually pay off the debt. This is exactly what happened after WWII, when the ratio of debt to GDP was far higher than it is now. Faster growth is not a magic bullet that cures all of our problems, but it sure does help a lot of them.
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