Published on Aug. 16, 2019
Keeping Cool in a Hot August
Trade battles, volatile equity markets, ten-year US Treasury yield flirting with the yield of the two-year Treasury and briefly inverting, and other scary headlines. What to make of it, particularly the inverted yield curve talk?
The inversion of the yield curve is said to be a marker of pending recession. While that may be true, it’s only one signal and there are a number of considerations that must be weighed.
The front end of the curve is pricing in further reductions in interest rates by the Federal Reserve. The back end of the curve has other factors driving it, which include low to negative interest rates in other markets, making the US rates look relatively enticing, and a benign inflation outlook. Bonds have also attracted safe-haven buyers, driving down yields, in the face of equity market volatility. Yes, there are tensions. Yes, there is a trade war, and global growth is slowing. Germany and China are leading examples, but none of this is necessarily a marker of pending recession in the US.
While our manufacturing data has deteriorated, the consumer, 75% of the economy, continues to roll along. Low levels of unemployment accompanied by good wage growth have produced high levels of consumer confidence. It seems that when times are good, the consumer goes shopping. When times are not so good, a shopping trip makes people feel better. Consumers consume! And reflecting the strong consumer, we think US GDP should probably be in the range of 2% for the next 12 months. We’ll be continuing to monitor consumer confidence as a key support factor for our economy in the coming months.
What typically causes recessions is either loss of access to credit or a pullback in risk-taking behavior. Credit is still available and flowing from banks and other financial institutions. Further, incidences of stress, distress, and defaults are not spiking up, which would be a typical precursor for banks and markets to begin to withdraw credit availability. Pullbacks in risk-taking typically have a behavioral element. Certainly, the world, and markets, are flush with risks and uncertainties, perhaps more in recent weeks than earlier in the year. In past cycles consumers and corporate management teams have been occasionally inclined to pull back on their spending in response to heightened periods of uncertainty and its negative impact on confidence levels. For now, we don’t see this playing out to the degree that would result in a recession. FDR would say that “all we have to fear is fear itself.”