Is the US going to get into a recession?

Outlook: The consumer is two-thirds of the US economy and if we are going to get a recession, first we have to see a change in consumer behavior. So far we are not seeing that. We are not sure that the Conference Board consumer confidence index today will be a good measure—we’d rather see what they do, not what they say. Whatever the Conference Board delivers, it can’t be as bad as the GfK indicator in Germany (see above).

And consumers are buying houses like there is a shortage or something, driving up prices dramatically. In the Jolts report, everyone will be looking for evidence of the labor shortage and more information on that quit rate.

Every newsletter and newspaper has the 5/30 yield curve inversion. White Rabbits are scurrying hither and yon, muttering “Oh my fur and whiskers! I'm late, I'm late, I'm late!” It’s the Fed considered late, aka “behind the curve.

But we say a yield curve inversion is irrelevant to the recession outlook, or relevant to something else, in a world in which the Fed holds $8.96 trillion of the $28.43 trillion debt outstanding (as of 3/15/22).

The yield curve debate is not going to fade away. Bloomberg reports that a Citigroup analyst says Powell is looking at the wrong yield curve (like the one we showed yesterday ending at 2 years). “Based in part on the deeply inverted eurodollar futures curve from June 2023 to June 2024, Citigroup calculates the risk of a U.S. recession in the next twelve months has risen to 20%, up from 9% in February. The dislocation between the spread Powell is focused on and the eurodollar curve is the largest since 1994, when a series of aggressive Fed rate hikes was followed by cuts the following year, according to Citigroup.” Recall that in 1994, there was no recession—and inflation was a whole lot lower. 

The analyst fails to note that in addition to low then-current inflation, inflation expectations were low. Besides, in 1994, Clinton was president and Gingrich had yet to shut down the US government. Russia was invading Chechnya. OJ Simpson was arrested and put on trial. Chain bookstores were all the rage (try to find one now). The internet was just catching hold. We had Netscape but not Explorer. There were only 45 billion pages and 4 billion users. Today Googles searches for 35 trillion sites.

Not least, total US debt outstanding in 1994 was $4.693 trillion. Today the Fed owns almost double that, or 32% of debt at $28.428 trillion. Should we be making comparisons? No.

We might say 1994 was an age of innocence, before quantitative easing and totally toxic politics. Don’t forget that Eurodollars were a Thing, whereas today they are on the way out and will be gone by June 2023 in favor or SOFR. Does that affect the chart? We don’t know, but while we can never say “this time it’s different,” we should also consider the overall environment and context. Today is not the same as 1994 in many ways that might be meaningful. Online trading did not exist. We had real-time cable news but actual live data cost an arm and a leg.  (It still costs an arm and a leg at Bloomberg.) We complained about information overload at the time but it got thousands of times worse.

Information counts. A lot. In 1929, a major contributor to panic was lack of information. The tape couldn’t keep up and traders were flying blind as often as not. Today we have nearly instant information and traders whose trading time horizon is 60-240 minutes, not days and weeks. We also have AI trading systems that see a seemingly statistically meaningful drop or rise in a price that gets magnified by traders jumping in any big move. And never mind you have no reason to get in—go back and invent one later.

Finally, this year we are coming out of a war—a pandemic can be likened to a war, economically—and in the middle of an authentic war. Wars are expensive, drive up budget deficits, screw up consumption/supply lines/savings, and make some market prices irrational. As if QE had not been enough to distort them in the first place. We continue to think QE alone suffices to make current conditions non-comparable to all previous sets of conditions, including curve inversion.

Bottom line, the flat yield curve reflect inflation expectations, not current inflation. The Eurodollar bounce can easily be something aberrant that one guy got started and others are, sheep-like, following. And even if it’s meaningful, a 20% chance of recession is pretty low, so what are we talking about, again? 

We are not alone in dissing the inverted yield curve talk. Bloomberg writes it could be a false signal, saying the yield curve is getting “flatter by design. The Federal Reserve has been propping up the economy in two ways: by keeping its crucial short-term federal funds rate near zero and by quantitative easing—buying Treasury securities to help keep longer-term rates down.”

“…Meanwhile, yields on longer-term Treasuries remain suppressed by the Fed’s quantitative easing. Until early March the central bank was still buying longer-dated Treasuries, helping to keep their prices high and yields low. The round of QE that began in March 2020 in response to the pandemic may have distorted the 30-year bond yield by about 50 basis points, estimates Morgan Stanley. So the yield curve may invert not in response to economic conditions but as a reflection of Fed policy.

“The financial community may learn to live with an inverted yield curve that’s not a signal of impending doom. Still it’s a pity that Fed policy has broken the most reliable barometer of recession risks.”

Oh, please. An inverted yield curve may have predicted most of the recessions in the past few decades, but over longer periods, it’s a lousy predictor. As Samuelson said, the inverted curve has predicted 37 of the last 5 recessions. Or something like that. We may as well get cute and watch other indicators for signs of recession, like men’s underwear sales, cheap lipstick, skyscraper construction, skirt lengths. Reuters has a list.

We are seeing the normal profit-taking and position-paring that is characteristic of month-end and quarter-end. We do not expect the yen to carry on so far that the BoJ intervenes. We admit to not understanding the AUD and CAD except they are decent alternatives to the USD, if that’s what you prefer. 

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