"Kee" Points with Jim Kee, Ph.D.

  • Last Week’s Inverted Yield Curve
  • The Economic Data

Last Week’s Inverted Yield Curve

Last week, the 10-year Treasury yield dipped below the 3-month Treasury bill yield, a true “inverted yield curve” with long rates below short rates. Since that is widely considered to be a recession signal, it is worth a closer look. In prior Kee Points I have mentioned a distinction between a “bearish flattening,” driven primarily by short rates coming up, and a “bullish flattening,” driven primarily by long rates coming down. This inversion appears to be driven by both, but with long rates coming down due to global growth concerns (e.g. Germany’s poor manufacturing numbers reported last week) and a flight into longer-term treasuries, driving up their prices and lowering yields (that’s bearish). So, in my opinion the signal flashed by last week’s inverted curve is unambiguously bearish, but the question is, does it portend a recession? I still do not think so, but it certainly reflects the near-term slowdown abroad, and in the US we see that in the economic numbers. Looking at the two big global issues at the moment - US trade negotiations (with China and Europe) and Brexit - one wonders whether or not we actually have more clarity now than we did six months ago. They’re both very fluid situations, but I would say the answer to both is "not really" and that’s why we’re seeing what the press is starting to call a synchronized slowdown, as opposed to the synchronized expansion observed a year ago.


 

The Economic Data

Looking at US data, the Atlanta Fed’s GDPNow model actually increased slightly to 1.3% for first quarter 2019 GDP growth, driven primarily by a surprising bounce in existing home sales for the month of February. Kevin Hassett, Chairman of the Council of Economic Advisors, made the case over the weekend that the government shutdown probably took away .3 percentage points, so he argued that the economy is actually growing closer to two percent and should accelerate from here. Hassett obviously has a bias (being nominated by President Trump), but he was accurate in forecasting last year’s US GDP growth and has a pretty good forecasting record. Less biased would be UCLA’s Anderson Forecasting Center, which stated that “There is not much in the GDP data on which to base an alarm of a soon-to-come recession.” My sense is that we are somewhere between the two. That is, we’ve hit a slow patch for sure, but two consecutive quarters of negative growth (i.e. recession) is not baked in the cake at this point. What makes forecasting tricky here is housing’s “failure to launch” during the current expansion, as housing and autos have traditionally been the early movers in signaling both expansion and decline. The Anderson center points out, however, that investments in intangible assets like intellectual property, software and development, and other corporate research and development have expanded faster than the economy. This should offset the weak performance of housing investments somewhat, and it should weaken the confidence in last week’s inverted yield curve forecasting a recession. One more point, made this morning by Bloomberg’s Mohamed A. El-Erian is that we still see tight credit or quality spreads, which typically widen prior to recession. So, spreads aren’t forecasting recession either. This is history in the making: we’ve had a legitimate yield curve inversion, and what remains is to track how the economy behaves going forward.