It’s been fun to watch the national media get reacquainted with the term, “inverted yield curve.” An inverted yield curve is when the short-term bond yields are higher than the long-term yields. Logically, this doesn’t make sense because the longer the investment, the more the investor should be paid. Logic would dictate an inverted yield curve means future trouble in the economy.
Economists measure the amount of the inversion by subtracting the 2-year yield from the 10-year yield. If the difference is negative, then it’s considered an official inverted yield curve. The curve has actually been inverted to some extent for most of 2019. An inverted yield curve has historically been an early warning signal of a recession.
What makes this inverted curve different is that economists have split into two camps – the recession will be here soon group and the no recession group. Economists have generally agreed that the inverted yield curve means an economic downturn is around the corner. The timing of the recession was always debatable, but there was little dissent on whether or not the recession was coming.
But now, the no recession camp has dug in their heels by believing that since there are no other signs of recession, the economy is in full speed ahead mode. Are there other recessionary signs? Let me count the ways.
There is usually a one year lag between the first sighting of an inverted curve and negative growth. In December 2007, the 10-year and 2-year bond yields inverted, and the negative growth sprouted in December 2008. Secondly, the U.S.’ leading trading partners are experiencing much lower or negative gross domestic product (GDP) which measures consumer and government spending. Finally, the housing sales have been negative for over a year primarily due to slow wage growth, mounting household debt, and changing attitudes toward home ownership.
U.S. retail sales have trended positive recently, but at a steep cost. Online sales remain very strong, but sales at brick and mortar retailers and shopping centers have flattened. This has led to shuttered physical locations which has resulted in depressed commercial real estate. Most major retailers, including financial institutions, have found that they need to have physical presence in key locations but have scaled down the size of those stores because they have become showrooms. More buyers are checking out the inventory at the stores but are actually buying online, which reduces the need for salespeople working on commission which subsequently negatively affects wage growth, which affects tax revenue, and hence GDP.
The Federal Reserve lowered the overnight interest rate last month. They are most concerned with inflation and unemployment, both presently at historically low levels. At this point, low interest rates won’t help GDP, home ownership, or future employment.
The fact remains that a recession will happen regardless of the so-called economic safeguards we install. Even in an increasing interconnected world, no one can stop economic cycles just like no one can stop weather cycles. All we can do is hunker down and make sure the roof doesn’t leak.