Has Recession Already Started?
“Sit down before fact like a little child,” Thomas Huxley instructed, and “follow humbly wherever and to whatever abyss Nature leads…”
Today we sit down before facts, childlike… and follow humbly wherever and to whatever abyss they lead.
But what if the facts lead straight to the abyss of recession?
Facts 1: April orders for core nondefense capital goods slipped 0.9%.
Facts 2: April orders for durable goods — items expected to endure three years or more — sank 2.1%. Durable goods shipments overall dropped 1.6%… the most since December 2015.
Facts 3: April orders for transportation equipment plunged 5.9%.
Facts 4: April retail sales slipped 0.2%.
Facts 5: The “yield curve” has inverted good and hard — a nearly perfect omen of recession.
Has Recession Already Arrived?
Stack facts 1–5 one atop the other. What can we conclude?
“U.S. recession probably started in the current quarter.”
This is the considered judgment of A. Gary Shilling. Mr. Shilling is a noted economist and financial analyst.
And he gazes into a crystal ball less murky than most.
In the spring of 1969, he was one of only a few analysts who correctly envisioned the recession at year’s end and was almost a lone voice in 1973… the first significant recession since the Great Depression.
But is not the economy still expanding?
Q1 GDP rang in at a hale and hearty 3.2% — after all.
But peer behind the numbers…
Much Less than Meets the Eye
Much of the jauntiness was owing to transitory factors such as inventory accumulation.
Firms squirreled away acorns to jump out ahead of looming tariffs, giving Q1 GDP a good jolt.
But that jolt has come. And that jolt has gone.
Meantime, Q2 GDP figures will come rising from the bureaucratic depths tomorrow morning.
What can you expect from them?
A severe letting down, it appears…
Q2 GDP Estimates Revised Downward
Morgan Stanley has lowered its Q2 GDP forecast from 1.0%… to a sickly 0.6%.
J.P. Morgan has lowered its own sights from 2.25% to 1%.
Meantime, the professional optimists of the Federal Reserve’s Atlanta command ring in at a slender 1.4%.
Miles and miles — all of them — from the first quarter’s 3.2%.
Might these experts botch the actual figure?
They may at that… and it would not be the first instance.
But the weight of evidence here assembled loads the scales in the other direction.
Besides, recessions first appear in the rearview mirror. They are only identified several months to one year post factum… if not longer.
Perhaps the economy has already started going backward, as Mr. A. Gary Shilling suggests.
Or perhaps he has spotted a phantom menace, a shadow, a false bugaboo.
What does the “yield curve” have to say?
The Message of the Yield Curve
The yield curve is simply the difference between short- and long-term interest rates.
Long-term rates normally run higher than short-term rates. This happy condition reflects the structure of time in a healthy market.
The 10-year yield, for example, should run substantially higher than the 3-month yield.
The reason is close by…
The 10-year Treasury yield rises when markets anticipate higher growth — and higher inflation.
Inflation eats away at money tied up in bonds… as a moth eats away at a cardigan.
Bond investors therefore demand greater compensation to hold a 10-year Treasury over a 3-month Treasury.
And the further out in the future, the greater the uncertainty. Thus the greater compensation investors demand for taking the long view.
Compensated, that is, for laying off the sparrow at hand… in exchange for the promise of two in the distant bush.
Time Itself Inverts
But when the 3-month yield and the 10-year yield begin to converge, the yield curve flattens… and time compresses.
When the 10-year yield falls beneath the 3-month yield, the yield curve is said to invert. And in this sense time itself inverts.
The signs that point to the future lead to the past. And vice versa.
In the careening confusion, future and past run right past one another… and end up switching places.
Thus, an inverted yield curve wrecks the market structure of time.
It rewards pursuit of the bird at hand greater than two in the future.
That is, the short-term bondholder is compensated more than the long-term bondholder.
That is, the short-term bondholder is paid more to sacrifice less… and the long-term bondholder paid less to sacrifice more.
That is, something is dreadfully off.
“A Nearly Perfect Omen of Lean Days Ahead”
An inverted yield curve is a nearly perfect omen of lean days ahead. It suggests an economic winter is coming… when investors expect little growth.
Explains Campbell Harvey, partner and senior adviser at Research Affiliates:
When the yield curve inverts, it’s not the time to borrow money to take a vacation to Orlando. It is the time to save, to build a cushion.
An inverted yield curve has accurately forecast all nine U.S. recessions since 1955.
Only once did it yell wolf — in the mid-1960s.
It has also foretold every major stock market calamity for the past 40 years.
The yield curve last inverted in 2007. Prior to 2007, the yield curve last inverted in 1998.
Violent shakings followed each inversion.
History reveals the woeful effects of an inverted yield curve do not manifest for an average 18 months.
And now, in 2019… the doomy portent drifts once again into view.
The Bond Market’s Strongest Signal Since the Financial Crisis
The 3-month and 10-year yield curve inverted in March. It has since straddled the zero line, leaning with the daily headlines.
But this week the inversion has gone steeply negative.
We are informed — reliably — that the yield curve has presently inverted to its deepest point since the financial crisis.
Why is the 3-month versus the 10-year yield curve so all-fired important?
Because that is the section of the yield curve the Federal Reserve tracks closest. It believes this portion gives the truest reading of economic health.
Others give the 10-year versus the 2-year curve a heavier weighting.
But it is the Federal Reserve that sets policy… not others.
Federal fund futures presently offer 86% odds that Mr. Powell will lower interest rates by December… and 60% odds by September.
If recession is not currently underway, we are confident the Federal Reserve’s next rate cut will start the countdown watch.
Come the next rate cut, recession will be three months off — or less.
Why do we crawl so far out upon this tree limb?
President Trump Should Demand Jerome Powell Not Raise Interest Rates
The next rate cut will be the first after a hiking cycle (which commenced in December 2015).
And the past three recessions each followed within 90 days of the first rate cut that ended a hike cycle.
Assume for now the pattern holds.
Assume further the Federal Reserve lowers interest rates later this year.
Add 90 days.
Thus the economy may drop into recession by early next year.
Allow several months for the bean counters at Washington to formally identify and announce it.
You may have just lobbed recession onto the unwanting lap of President Donald John Trump… in time for the furious 2020 election season.
Could the timing be worse for the presidential incumbent?
Mr. Trump has previously attempted to blackjack Jerome Powell into lowering rates.
But if our analysis holds together…
The president should fall upon both knees… and beg Mr. Powell to keep rates right where they are…
Managing editor, The Daily Reckoning