Pedestrians walk along Wall Street near the New York Stock Exchange (NYSE) in the United States on Thursday, May 16, 2024.
Alex Kent | Bloomberg | Getty Images
Wall Street’s favorite recession signal started flashing red in 2022 and hasn’t stopped — and every step has been wrong so far.
The rate of return is 10 Year Treasury Bill During this period, yields have been lower than most short-term yields, a phenomenon known as an inverted yield curve that has preceded nearly every recession since the 1950s.
However, despite conventional wisdom that a recession should occur within a year or at most two years of an inversion of the curve, not only has U.S. economic growth not happened, there are no red numbers in sight.
The situation has left many on Wall Street scratching their heads as to why the inversion of the curve – both a signal and in some ways a cause of recession – went so wrong this time, and whether it’s a continuing sign of economic danger.
“Yeah, it’s been a flat-out liar so far,” said Mark Zandi, chief economist at Moody’s Analytics, half-jokingly. “This is the first time it’s been flipped upside down and a recession hasn’t followed. But having said that, I don’t think we’re comfortable with the continued inversion. So far, it’s been wrong, but that doesn’t mean it will always be wrong.
Depending on which duration point you consider most relevant, the curve will either begin inverting in July 2022 (as measured by the 2-year Treasury yield) or start inverting in October of the same year (as measured by the three-month Treasury yield) change. Some even like to use the federal funds rate, which is what banks charge each other for overnight lending, which would keep the inversion going until November 2022.
Whichever point you choose, the recession should be here by now. This inversion went wrong only once, in the mid-1960s, and has foreshadowed every layoff since.
According to the New York Fed, which uses a 10-year/three-month curve, a recession should occur in about 12 months. In fact, the central bank still allocates About 56% chance As the current gap indicates, the economy will be in recession by June 2025.
“It’s been so long that you have to start questioning its usefulness,” said Joseph LaVorgna, chief economist at SMBC Nikko Securities. “I just don’t understand how a curve can be so long over so long. Something went wrong inside. I’m leaning toward it being broken, but I’m not completely surrendered yet.”
Reversals are not alone
Complicating matters further, the yield curve is not the only indicator that suggests there is reason to be cautious about how long the post-COVID-19 recovery will last.
Since the third quarter of 2022, gross domestic product (the sum of all goods and services produced in the vast U.S. economy) has averaged an annualized real quarterly growth rate of about 2.7%, which is quite strong and well above Trend growth around 2%.
Previously, GDP was negative for two consecutive quarters. meet technical definition Although few expected the National Bureau of Economic Research to officially declare a recession.
The U.S. Commerce Department on Thursday is expected to report GDP growth of 2.1% in the second quarter of 2024.
However, economists have been watching some negative trends.
Sam’s RuleA fail-safe indicator, which says a recession will occur when the three-month average unemployment rate is half a percentage point above the 12-month low, is about to be triggered. On top of that, the money supply has been on a steady downward trajectory since peaking in April 2022, and The Conference Board Leading Economic Indicators Index It has been negative for a long time, indicating significant headwinds to growth.
“A lot of these measures are being questioned,” said Quincy Krosby, chief global strategist at LPL Financial. “At some point, we’re going to be in a recession.”
However, a recession has not yet occurred.
What’s different this time
“We have a lot of different indicators that haven’t panned out yet,” said Jim Paulsen, a veteran economist and strategist who has worked at companies including Wells Fargo. “We’ve been through a lot of recession-like things.”
Paulsen, who now writes a Substack blog called Paulsen Perspectives, points to some anomalies that have occurred over the past few years as possible reasons for the discrepancy.
First, he and others point out that the economy actually experiences a technical recession before inverting. On the other hand, he cited the Fed’s unusual behavior during the current cycle.
Faced with the highest runaway inflation rate in more than 40 years, The Fed begins to raise interest rates Gradually in March 2022, then more aggressively in the middle of the year (i.e. after the peak of inflation in June 2022). Historically, the Fed has raised rates early in an inflationary cycle and then begun to cut rates.
“They waited until inflation peaked and then tightened it all the way. So the Fed was completely out of sync,” Paulson said.
But interest rate dynamics have helped companies escape what typically happens in an inverted curve.
One of the reasons that inverted curves can cause a recession and signal that a recession is occurring is that they make short-term money more expensive. For example, this is difficult for banks that borrow short and lend too much. As the inverted curve hits net interest margins, banks may choose to lend less, leading to a decline in consumer spending and a subsequent recession.
But this time, companies were able to lock in lower long-term rates before the Fed started raising rates, providing a buffer against rising short-term rates.
However, this trend increases the Fed’s risks as much of the financing is about to expire.
If current high interest rates remain in effect, companies that need to roll over debt may face a more difficult time. This could provide a self-fulfilling prophecy of sorts for the yield curve. The Fed has been on hold for a year, with its benchmark interest rate at a 23-year high.
“So it’s very possible that the curve has been lying to us so far. But it may soon decide to start telling the truth,” Moody’s economist Zandi said. “The inversion of the curve makes me very uncomfortable. This is the Fed Another reason why rates should be lowered.”
