A new measure of financial conditions shows the US economy heading for a rough patch

The US economy looks like it’s headed for a spell of weakness, a veteran strategist is warning.

Jim Paulsen, a Wall Street economist and the former chief investment strategist at the Leuthold Group, sees a troubling trajectory ahead for the US, with the economy likely to see weak growth going forward, pressured by a “cocktail of past contractionary forces” acting on the economy, he wrote on his Substack this week.

Paulsen said he created a new gauge to measure tightness of financial conditions, pointing to how accommodative or restrictive the broader macro backdrop is for growth. The Leading Financial Conditions Gauge measures five economic policies and three economic forces. It has proven to be a leading indicator of economic growth and stock prices, Paulsen said, citing his analysis of the gauge’s swings dating back to 1970.

Of the eight indicators in the model, seven represent a contractionary force on the economy, Paulsen said. Here’s the rundown of the gauge’s contractionary signals:

• Long-term and short-term yields are rising. The benchmark 10-year US Treasury yield hit a new post-Financial Crisis peak this week, rising as high as 5.09%. The 2-year Treasury yield, meanwhile, rose to 4.89%, its highest level in about two years as investors fretted about the outlook for inflation and US fiscal health.
• The yield curve has flattened, which indicates that short-term yields are rising faster relative to long-term yields. That points to market expectations for higher short-term rates, which can slow the economy.

• Fiscal support could be fading. The US’s net deficit spending is falling, a sign that the economy isn’t getting as much fiscal stimulus as it used to. The federal budget deficit clocked in at $2 trillion in the first 11 months of the 2026 fiscal year, $6 billion less compared to the same period last year, according to estimates from the Congressional Budget Office.
• Oil prices are higher. Brent crude, the international benchmark, traded around $101 a barrel on Wednesday, sitting above the critical $100-a-barrel mark.
• Inflation is rising. The consumer price index held steady in August, but there are other indicators that suggest inflation is accelerating. Core CPI, which excludes volatile food and energy prices, rose 0.3% last month, above last month’s 0.2% gain.
• Real wages are falling. After accounting for inflation, average hourly earnings for all workers fell 0.1% in August, according to the Bureau of Labor Statistics.

Paulsen’s gauge of market and economic conditions currently sits in its topmost quartile, signaling that financial conditions are tight. Historically, every major recession in the US has been preceded by the gauge rising to that level, he said.

Paulsen questioned whether the Fed should raise interest rates further from current levels. Central bankers, though, have come out with hawkish comments on the outlook for monetary policy in recent weeks, and markets see two more Fed rate hikes by year-end.

“My guess is it will prove to be a mistake that the Fed became more restrictive ‘after’ the Leading Financial Conditions Gauge just surged to its most contractionary quartile. Expect weaker economic growth, rising recession fears (although probably no actual recession), lower—not higher—bond yields, and a more challenging stock market in the coming months,” Paulsen wrote.

Paulsen has issued bearish warnings on markets and the economy for months as the Iran war has unfolded and as oil prices have climbed. In the past, he’s flagged the potential for a major stock correction as well as a downturn, though a full-blown recession isn’t his base case.