One thing we can say for sure is that markets don’t seem to like having a “Tariff Man,” as President Trump described himself Tuesday, in the White House. Not when stocks sold off more than 3 percent in response to Trump’s latest 280-character ode to trade barriers, as he partially backed off his earlier assurances that he would be able to strike an “incredible” trade deal with China.
To be fair, though, this wasn’t the only reason that markets had such a disastrous day. Indeed, it might not have even been the most important one. That was because the most accurate recession predictor we have — the difference between the government’s long-term and short-term borrowing costs — has gone from flashing yellow to being awfully close to red.
Specifically, the gap between interest rates on 10-year U.S. Treasury bonds and two-year ones has hit a new 11-year low of 0.12 percentage points. This, as anyone who has a mortgage can tell you, is not the way things normally work. Usually, after all, you have to pay a much higher interest rate to borrow money for a longer period of time. So why would the opposite — what’s known as an “inverted yield curve” — ever be the case for Uncle Sam?
The answer is that, because the U.S. government is generally considered the safest borrower in the world, its long-term borrowing costs are just a function of what its short-term borrowing costs are expected to be in the future. Which, while it might sound simple, is profound. That’s because short-term interest rates are themselves driven by the state of the economy: The Federal Reserve raises them when things are going well to keep inflation from getting too high and cuts them when things are looking bad to keep unemployment from rising too much. Put it all together, then, and long-term rates being lower than short-term rates today means that markets think short-term rates are going to get lower tomorrow — which would only happen if a recession were to hit.
Now, if you’re a yield-curve-half-full kind of person, you’d point out that Federal Reserve Board Chair Jerome H. Powell recently seemed to say that they might not end up raising rates as much as people had thought. Or that Dallas Fed chief Robert Kaplan thinks they can afford — and need — to be “very patient” hiking rates from here on out. Or that Minneapolis Fed President Neel Kashkari doesn’t see much of a case for increasing interest rates at all right now. But if you’re a yield-curve-half-empty of person, you’d reply that markets probably read too much into what were fairly anodyne comments from Powell. Or that Fed governor Lael Brainard, who has been one of the central bank’s more dovish members, seemed to downplay the risk of them pushing short-term rates higher than long-term ones in a speech in September. Or that a small part of the curve — the difference between five-year and three-year bonds — already inverted a few days ago.
All of which is to say that the dark lining to what’s been our silver cloud of good economic news looks as if it’s getting a bit more ominous. That might seem hard to believe when interest rates are 2.25 percent and unemployment is a mere 3.7 percent, but we’re still stuck in enough of the shadow of the Great Recession that it wouldn’t take much to nudge us out of the virtuous circle we’ve been in. Slightly higher interest rates might do it. So could a trade war. Or maybe the slowdown in the rest of the world catching up to us. The point is that, for the first time in a long time, there are real reasons to worry about the recovery. They aren’t here yet, but they could be soon — if history is any guide, maybe in the next 12 to 18 months.
In that case, Trump might be what no president wants to be in an election year: a recession man.