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.
