Leftists had that thrill up their leg again, unseen since the election of President Barack Obama. Like democratic socialists when they see a portrait of Karl Marx and Sen. Bernie Sanders (I-VT), many people who wish the economy would collapse to own President Donald Trump had stars in their eyes when learning of a recent and historic market event. But, much like the results of the 2016 election, the left will likely be disappointed yet again when they find out that nothing will come of the inverted yield curve this time. Well, there is always Russia to fall back on if a recession doesn’t happen.
Yield for Inversion
In the bond market, investors demand a higher rate of return when they are buying long-term bonds (or lending money for extended periods) because there are greater risks. However, for the second time since the spring, this has inverted: Short-term rates are higher than longer-term bond yields.
The primary measurement of the yield curve inverted for as long as Rep. Eric Swalwell’s (D-CA) campaign for president. Faster than you can say Cat in the Hat, the yield on the 10-year Treasury note slipped below the two-year note, spooking financial markets and generating triple-digit losses. What has also flown under the radar is that the yield on the 30-year note plunged to an all-time low of 2.01%.
But are traders hitting the sell button a bit too prematurely?
Since 1965, whenever the curve turned negative, a recession would typically follow. The one time it did not occur was in 1990, but it did hover just above subzero territory. The consensus on the Street is that it is a strong indicator of an upcoming downturn.
As the old adage goes, though, the times they are a-changin’.
Striking Out on a Curve
One of the reasons it might not be such a trusted measurement is that the panoply of quantitative easing (QE) programs implemented by central banks around the world have eviscerated the dependability of inversions as a forecasting tool. In Europe and Japan, a plethora of bond yields has turned negative, sending investors, who are desperate for any type of yield, to US markets. This suppresses long-term Treasury yields.
The other issue is that the bubbling bond market might be signaling that the Federal Reserve is on the cusp of instituting heightened accommodation. The central bank cut interest rates by 25 basis points earlier this month, and the market is penciling in another rate cut in September. Plus, the Fed has hit the pause button on unwinding its $3.8 trillion balance sheet. Should the Eccles Building extend its monetary easing cycle, then it would enable long-term Treasury yields beneath their short-term counterparts.
And, if you subscribe to the Austrian School of Economics, then the conclusion is that the upward sloping yield curve is unsustainable anyway. As Liberty Nation reported:
“They argue that it initiates taking advantage of price differences in other markets – arbitrage – that transition from short to long maturities, increasing short-term rates, and decreasing long-term rates, which produces a uniform interest rate.”
Overall, the development should not come as a huge shock to investors since rates have been low for a long time, a trend that might spur lending demand volumes.
That said, even if this incarnation of the yield curve inversion were accurate, then investors have more than a year to adapt. According to the Bank of America Merrill Lynch, recessions have transpired, on average, 15 months after the inversion. If this is true, then the downturn would happen just after the next presidential election, which would be interesting timing, to say the least.
Deepest Recessions of the Market
The left may need to wait a little bit longer to get the recession they are salivating for. While there is a bubblemania occurring and everything is highly inflated, the next time two bears talk at a party about the economy might not happen for another year – maybe two or three. The latest Federal Reserve data suggest the money supply has skyrocketed, flooding the market with cheap money. When you factor in an accommodative Fed, priming the pump could help extend the bull market until at least the next election.
Long-term, the US economy is in bad shape. The national debt is skyrocketing, unfunded liabilities and expenditures exceed $200 trillion, there is a bubble in everything, and the central bank has exhausted all conventional and unconventional tools to spur growth. For now, the US economy is roaring, but if this recession hits right after the president wins reelection, he come to wish he hadn’t. The next financial crisis to come will be nothing like the 2008 meltdown.
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