March 29, 2019

Inverted, What Isn’t?

They have no illusions about the system, but plenty of illusions about the way to change our world.” ------ Ralph Waldo Emerson

Much has been written and broadcast lately regarding the recent inversion of the yield curve (3 month yield higher than the 10-year yield). In fact, the first inversion took place in December of last year prompted by Fed insistence on raising rates one last time. Each event gave fuel to the naysayers and nihilists, armed with history, and an expert or two, to bring fear to the markets, all captured beautifully by the social platforms and the algorithms…the recession was near. Sorry, I don’t agree.

The Inversion Curve
Yield curve inversion has been a reliable predictor of recessions for my entire career. However, the yield curve is not the cause of recessions. And that’s where the process gets lost. Reasons for inversion are usually the results of excess Federal Reserve rate increases, increases that are exclusively limited to the interbank lending rate (Fed Funds Rate), an ultra short-term rate designed to curb excess borrowing between banks and thereby between banks and potential customers. Therefore, it’s the shortest Treasury rates that generally rise in sync and anticipation. This sets the trend over time that could result in rapid inversion as it did from 2003 until 2006 when the Federal Reserve was raising rates monthly. But this week, for the second time in three months Fed Chairman Powell announced the Federal Reserve Board Voting Body would wait and watch incoming data before proceeding. In the last quarter after the statement the threat of curve inversion disappeared, this quarter it may do the same. The outcome is not to suggest the inversion never happened, but can suggest a more modest immediacy for recession.

The Economic Curve
As mentioned above, last week Fed Chairman Powell announced further time would have to pass before considering to increase rates again. This occurred after the last release of February job growth data, and followed by moderation in housing sales, a drop in consumer sentiment and also consumer prices (i.e. inflation). I could go on and suggest that employment was the result of well advertised layoffs late last year, while the unemployment rate, participation rate and earnings measured by the Employment Cost Index (ECI) rose above 3% for the first time in over 10 years. And as the ECI increases so does the rate of consumer consumption, and we know how much they like to do that. Next, housing sales always decline in the winter, therefore it’s always wiser to look at newly distributed permits for new growth, which although declining they are actually showing slowing growth. In the meantime, February Existing Home Sales could rise in the next few months reflecting the recent decline in yields along with mortgage rates. As for the consumer, it would be great if I had access to airline and hotel reservations, or even destinations, but alas all I can point to is the upcoming summer when discretionary spending seasonally rises. Am I confident of these outcomes, no, for now they’re just my opinion?

The Interesting Factor
The biggest challenge facing the markets in the foreseeable future is not a recession in my opinion, it’s the fear of recession. Fear reflected in the media narrative, and especially the fear feed to us through our technology reduced to algorithmic grammar poised to initiate selling, unemployment moves higher, SELL! (thinks the computer) Trade talks with China collapse, SELL! (Beep), hence the ongoing challenge of making decisions in a historically volatile world. But ignore the noise and see that there is logic of curve inversion signaling economic change. But my attention is also at when the short end of the yield curve has a higher yield than the average Dividend Yield (%) of all Dow Jones Industrial Average stocks of 2.62%, which it doesn’t. The interesting factor rests into a culture that has locked itself in a self-reinforcing bubble to defend bearishness. That, or its good for business. However, in short, the inverted yield curve doesn’t itself portend the end of the world, but it shouldn’t be ignored either. And when recession hits, when not if, I have one space that is diverting my attention in the meantime, Real Estate, stay tuned.