The first thing to know about Wednesday’s yield curve inversion is that it won’t itself cause a recession. The second thing to know is that it may signal one is close at hand.
For the first time since 2007, a two-year Treasury bond offered investors a higher return than a 10-year bond:
"In a healthy economy, bondholders typically demand to be paid more — or receive a higher 'yield' — on longer-term bonds than they do for short-term bonds," my colleague Jonnelle Marte explains. "That’s because longer term bonds require people to lock their money up for a greater period of time — and investors want to be compensated for that risk. In contrast, bonds that require investors to make shorter time commitments, say for three months, don’t require as much sacrifice and usually pay less."
The curve inverts when investors pile into longer-term debt for protection against what they see as deteriorating short-term conditions — and the phenomenon has successfully predicted every recession dating back 50 years:
So understandably spooked investors dumped stocks on Wednesday, sending the major stock indexes spiraling down about 3 percent for the market’s worst day of the year. The yield on 30-year Treasury notes has since slipped below 2 percent for the first time ever in another signal of investors' flight to safey. (Other portions of the yield curve have already inverted in recent months, with the yield on the 5-year note falling below that of the 3-year in December; the rate on the 10-year note fell below that of the 3-month note in March.)
The developments in the bond market merely reflect broader macroeconomic conditions. The developments in the bond market merely reflect broader macroeconomic conditions. And many of those have been instigated by President Trump, whose ongoing trade offensive against China is darkening the global outlook.
But those conditions are offering plenty of reasons to worry that the record-length U.S. economic expansion could be on its last legs: Global growth is slowing, with Germany’s economy shrinking in the second quarter; a raft of data out of the U.K. and China showing those powerhouses stumbling, too; and Argentina flirting with a financial crisis, as its stock market has lost nearly half its value in recent days. At home, the U.S.-China trade war has only escalated in recent weeks, despite the partial reprieve President Trump offered from his latest tariff hike, casting a cloud of uncertainty that’s choking business investment and hiring.
Then again, some market watchers argue, the 10-year Treasury yield briefly falling below that of the two-year on Wednesday doesn’t guarantee that a recession is imminent. And investors should be wary of overreacting. For one thing, recent history suggests there’s frequently a lengthy interval — of a year or even two years — between a yield curve inversion and the next recession. As Todd Sohn, a technical analyst at Strategas, points out in an email:
- The yield curve inverted in December 1988, but a recession did not follow until July 1990, a year and a half later.
- Another happened in June 1998, and a recession didn’t follow until March 2001, over two and a half years later (though another inversion occurred in February 2000).
- The inversion credited with predicting the recession from the financial crisis occurred in December 2005, two years before that recession officially began.
And in the meantime, the stock market more often than not outperforms in the year following an inversion, as this Strategas chart shows:
Other economists warned against taking the inversion as gospel about the likelihood of a recession. “Historically, it has been a pretty good signal of recession, and I think that’s when markets pay attention to it, but I would really urge that on this occasion it may be a less good signal,” former Federal Reserve chair Janet Yellen said on Fox Business Network. “The reason for that is there are a number of factors other than market expectations about the future path of interest rates that are pushing down long-term yields.”
For her part, Yellen said she doesn’t think the economy is headed for a recession, “but the odds have clearly risen and they’re higher than I’m frankly comfortable with.”
Similarly, University of Oregon economist Tim Duy offered a measured take on the day’s news, arguing the yield curve inversion “does not mean that a recession is on top of us or that it couldn’t be averted. It does mean that the risks of recession are higher.”
He laid the blame for policy uncertainty squarely at the feet of the president and said Trump will determine what happens next. “We should recognize that if we stay on this path much longer, rumors will again swirl that Trump is going to fire [Fed chair Jerome Powell]. I don’t think Powell would back down; the Fed would fight an attempted firing. I can’t imagine though that financial market participants would patiently wait for the matter to be settled in the courts. I think market conditions would turn ugly.”
Trump didn’t do much Wednesday to inspire confidence he will be a steadying hand. Instead, he took to Twitter to make clear he will continue to blame the Fed for any and all economic turbulence:
“The Fed has got to do something! The Fed is the Central Bank of the United States, not the Central Bank of the World.” Mark Grant @Varneyco Correct! The Federal Reserve acted far too quickly, and now is very, very late. Too bad, so much to gain on the upside!— Donald J. Trump (@realDonaldTrump) August 14, 2019
Tremendous amounts of money pouring into the United States. People want safety!— Donald J. Trump (@realDonaldTrump) August 14, 2019
The Great Charles Payne @cvpayne correctly stated that Fed Chair Jay Powell made TWO enormous mistakes. 1. When he said “mid cycle adjustment.” 2. We’re data dependent. “He did not do the right thing.” I agree (to put it mildly!). @Varneyco— Donald J. Trump (@realDonaldTrump) August 14, 2019
..Spread is way too much as other countries say THANK YOU to clueless Jay Powell and the Federal Reserve. Germany, and many others, are playing the game! CRAZY INVERTED YIELD CURVE! We should easily be reaping big Rewards & Gains, but the Fed is holding us back. We will Win!— Donald J. Trump (@realDonaldTrump) August 14, 2019
The bash-the-Fed strategy appears born of a sense in the White House that the administration lacks better options.
“Several White House officials have become concerned that the economy is weakening faster than expected, but they are not working on proactive plans to change its course,” my colleagues Damian Paletta, Thomas Heath and Taylor Telford report. “The Treasury Department has had an exodus of senior advisers in recent months, and the White House just announced a replacement for its chairman of the Council of Economic Advisers. Instead of rolling out new policies, Trump and other top aides have escalated their attacks on the Federal Reserve, trying to pin much of the United States’ problems on what Trump alleges is elevated interest rates that are strangling growth.”
But RSM chief economist Joe Brusuelas, in a Wednesday note to clients, said Trump’s trade policy will shape whether the recession comes to pass.
“While the U.S. economy is not yet in recession… the inversion of the yield curve and the appearance of real negative yields clearly indicates that the business cycle has entered its final stages and recession risks are elevated,” Bruseulas wrote. “In our estimation, there would need to be a clear signal of a permanent cessation of trade hostilities between Washington and Beijing to turn around risk and business sentiment.”
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— China signals retaliation for latest tariffs. Bloomberg: "China called planned U.S. tariffs on an additional $300 billion in Chinese goods a violation of accords reached by Presidents Donald Trump and Xi Jinping, signaling an American move earlier this week to delay some of those levies was not enough to stave off retaliation.
"The new 10% tariffs have taken the U.S. and China off the track of resolving their dispute through negotiation, the State Council Tariff Committee, which has overseen tit-for-tat retaliation, said in a short statement on Thursday. China 'has no choice but to take necessary measures to retaliate,' it said, without specifying what the nation would do."
— Trump suggests tying trade deal to Hong Kong: "[Trump] suggested a 'personal meeting' with China’s President Xi Jinping to discuss the escalating crisis in Hong Kong and warned China it must respond 'humanely' to the protests if it wants to strike a trade deal," WSJ's Vivian Salama and Alex Leary report.
I know President Xi of China very well. He is a great leader who very much has the respect of his people. He is also a good man in a “tough business.” I have ZERO doubt that if President Xi wants to quickly and humanely solve the Hong Kong problem, he can do it. Personal meeting?— Donald J. Trump (@realDonaldTrump) August 14, 2019
"Mr. Trump’s statement via Twitter marked a shift in tone in his public statements regarding the situation in Hong Kong and for the first time linked the administration’s fragile trade talks with Beijing to the protests. The Wednesday evening tweets came amid growing concern within the administration that China would respond with military force to the antigovernment protests that have shut down Hong Kong’s major international airport for the past two days."
— Advantage, China: “[Trump’s] new tariffs on Chinese agricultural products are likely to hurt the Asian nation a lot less than the retaliatory duties Beijing already imposes on the U.S.,” Bloomberg News reports.
“ … The amount of farm products China exports to the U.S. is much smaller than what it imports from America, even with the retaliatory tariffs in place. China shipped $3.1 billion worth of farm goods to America in the first half of this year, while it purchased $5.6 billion of U.S. agricultural items over the same period, according to Chinese customs data.”
— Au ful news: “China has severely restricted imports of gold since May, bullion industry sources with direct knowledge of the matter told Reuters, in a move that could be aimed at curbing outflows of dollars and bolstering its yuan currency as economic growth slows,” Reuters’s Peter Hobson and Yawen Chen report.
“The world’s second largest economy has cut shipments by some 300-500 tonnes compared with last year — worth $15-25 billion at current prices, the sources said, speaking on condition of anonymity because they are not authorized to speak to the media.”
— Pelosi says no deal if Good Friday accord is undermined: “An American trade pact with Britain is doomed if the latter's withdrawal from the EU undermines the Northern Ireland peace accord, House Speaker Nancy Pelosi warned Wednesday,” AFP reports.
“‘Whatever form it takes, Brexit cannot be allowed to imperil the Good Friday Agreement, including the seamless border between the Irish Republic and Northern Ireland,’ [Pelosi] said in a statement. The 1998 Good Friday Agreement brought the decades-old Northern Ireland conflict to an end. But how to handle Northern Ireland has emerged as a core issue for Brexit negotiators.”
— Retail stocks hit decade lows: “Shares of department stores Nordstrom, Kohl’s, Dilliard’s, and J.C. Penney tanked Wednesday after Macy’s lowered its profit outlook in an earnings miss that underlined challenges in the retail sector,” CNBC’s Jasmine Wu reports.
“Macy’s shares closed Wednesday down 13%, while Nordstrom and Kohl’s skidded 10%, J.C. Penney dropped nearly 5% and Dillard’s was less than 2% lower. Macy’s fell to its lowest level since February 2010, while Nordstrom’s low was its worst since July 2009.”
— Even Crypto is taking a hit: “Bitcoin is quickly losing the refuge designation bestowed by some advocates in recent weeks as the largest cryptocurrency joins the global slide in riskier assets. Smaller rivals tumbled even further,” Bloomberg News’s Olga Kharif reports.
“After rallying while U.S. equities plunged earlier in the month, Bitcoin has followed stocks lower, with the digital asset tumbling about 14% this week to push its price to around $10,200. The token, which last traded below $10,000 on Aug. 1, had climbed as high as $13,852 on June 26. Ether slumped as much as 12% Wednesday, while XRP slumped as much as 20% in a sudden early afternoon sell-off.”
— IPO boards have a glaring problem: “WeWork Cos.’s proposal to go public later this year with an all-male board is all too common among new companies — and it’s diluting gains for women in public company boardrooms,” Bloomberg News's Jeff Green reports.
“About 40% of open director roles at S&P 500 companies were filled by women last year. But in public offerings since April, women have only occupied about 18% of the new spots, according to G. Fleck / Board Services, a New York executive recruiter that tracks board changes.”
Words matter, especially if you’re a CEO: “Overstock.com Inc. shares fell for a third day Wednesday as investors reacted to statements by Chief Executive Officer Patrick Byrne that he was a part of federal investigations related to the 2016 election,” Bloomberg News’s Jeran Wittenstein report.
“The e-commerce company has lost a third of its value in the two days since releasing a statement by Byrne titled ‘Overstock.com CEO Comments on Deep State’ and referring to federal investigators as ‘the Men in Black.’ The stock fell another 23% on Wednesday, bringing its slide to 36% since Monday, the biggest two-day slump in more than 11 years.”
— Epstein 2003 interview unearthed: “There are questions Jeffrey Epstein will never answer now. But a lifetime ago — long before his dark journey ended in an apparent suicide in a Manhattan jail cell — Epstein settled into a sling-back chair on his private Caribbean island and began talking,” BloombergNews’s Tom Metcalf reports.
“The financier was, [journalist Doug] Bank recalled, friendly and gracious, eager to pontificate about many things but cagey about exactly what he did in his role as financial adviser to Leslie Wexner, the billionaire he met in Palm Beach in the 1980s and who opened doors for him in business and finance and beyond … He did, though, touch a bit on the control he had over the finances of the Victoria’s Secret mogul. ‘I don’t tell him what sweaters to buy, he doesn’t tell me when to buy or sell stock.’ ”
— Warren calls for probe into FTC’s statements on Equifax settlement: “Not everyone is going to receive the $125 they might have expected out of a settlement between Equifax and government regulators over its 2017 security breach — and Sen. Elizabeth Warren of Massachusetts is asking why,” my colleague Tony Romm reports.
“For the Democratic lawmaker and 2020 presidential candidate, the concern is that the Federal Trade Commission, one of the agencies that probed Equifax, initially offered ‘misleading public descriptions’ about the relief available to the roughly 147 million Americans whose names, addresses and Social Security numbers had been compromised. In response, Warren is asking the agency’s inspector general to probe both the ‘terms of and FTC’s public description of the settlement.’”
- Walmart, Alibaba and JCPenney and IHeartMedia are among the notable companies reporting their earnings, per Kiplinger.