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

  • Midyear Overview
  • So No Recession?


Midyear Overview

I have looked at a lot of midyear outlook pieces this month, and I would say that the Federal Reserve Bank of San Francisco’s recent FedViews provides a fair representation of the consensus view. That is, US economic growth is expected to continue at a modest pace. Inflation remains below the Fed’s 2% target but should move up towards it over the next 6-12 months. At the end of June, the current expansion will have been 120 months in duration, tying the 1991-2001 expansion, which was the longest on record. Growth is expected to slow to around 2%, which is what the Atlanta Fed’s GDPNow model is reflecting for the second quarter of this year (real GDP growth was 3.1% annualized in the first quarter, and averaged 3.2% over the past four quarters).

As an interesting aside to all of this, former Federal Reserve Bank of Minneapolis president Narayana Kocherlakota wrote in a recent Bloomberg column that a long, weak expansion is nothing to celebrate, preferring instead a less stable economy with a higher average growth rate. He argues that long periods without slumps often indicate many years of poor economic performance. I’m not sure I agree with Kocherlakota, but I thought Kee Points readers would find his views of interest. I do believe that a stable policy environment (i.e. fiscal and monetary policy) leads to a dynamic economy, which probably is characterized by more uneven growth, so maybe I am with him on that.

Back to the economy. While the May jobs number of 75,000 was disappointing, the April number was 224,000, and the far more meaningful six-month average is 175,000 new jobs created per month. That is above what the San Francisco Fed considers the amount necessary to absorb new entrants, which is estimated to be about 90,000 new jobs per month (Federal Reserve Bank of San Francisco). Looking overseas, political uncertainties like Brexit and trade tensions remain the key issues weighing down business confidence (Wells Fargo Investment Institute), and low business confidence in-turn depresses the commitment of capital and hiring that long-term growth requires. Most analysts agree that some of these political uncertainties must be resolved before a sustained period of strong international equity performance – including emerging market equities – can occur. The June 2019 G20 summit is next up on that note, and strategist Greg Valliere, with whom we’ve consulted in the past, doesn’t expect a real breakthrough on trade issues at that time. He does anticipate an eventual trade deal, perhaps by fall (Valliere’s Morning Bullets).

So No Recession?

Few strategists expect a pending recession, but all show concern over the flat-to-inverted yield curve. Currently the 10-year Treasury bond yield is a few basis points below the 3-month Treasury bill yield (i.e. inverted), and both are just above 2%. I like the San Francisco Fed’s take on this as well: On the one hand, the yield curve has had an amazing track record at predicting recessions. On the other hand, the quantitative easing programs implemented by the Fed to buy longer-maturity Treasury securities could be distorting the yield curve’s signal (as could negative international rates). Their conclusion lacks the excitement or implicit certainty of the current media coverage of yield curve phenomena, but I think it is the right way to think about it, and that is, “Deciding between these views is challenging because the lack of historical precedent limits a full statistical analysis of the current environment.” I would like to reiterate that this regime of rate hikes is somewhat unique. Under past regimes, the Fed would raise rates as it saw growth and/or inflation numbers getting too strong. This rate hike regime began under the desire to “normalize” rates that had been held near zero for almost seven years. The thinking was, “unless the economy is too weak, or unless inflation numbers are too low, we’re going to raise rates.” That is a fundamental difference, and I think it is why markets are having a hard time anticipating the Fed, and why the Fed is having some internal dissention over what to do. Recently, the Federal Open Market Committee voted to keep the benchmark (federal funds) rate in the target range of 2.25% to 2.5%. I think the Fed should just leave things alone for a while, but I don’t have a vote! For what all this means for fixed-income investors and for rate expectations through year’s end, please see our forthcoming STMM Fixed Income Monthly Reportby Josh Hudson, STMM’s Director of Fixed Income.