In case you missed it, or in case you thought things were looking up lately, the yield curve inversion has just gotten even worse. And that's using the "gold standard" three-month versus 10-year Treasury yield, with a nearly perfect historical track record of predicting recessions!
There is a huge temptation to dismiss this. "I feel like I've been reading about inverted yield curves for several years now," sighed one observer on Twitter. Even heavy-hitters on Wall Street are questioning the usefulness of this indicator. J.P. Morgan economist Michael Feroli just put out a report saying the inversion may only be predicting a sharp drop in inflation this time around--a good thing--as opposed to a recession. And Goldman equity analysts think it's happening because investors are pricing in too-low inflation in the longer run, which they don't think we'll return to this time around.
But to any of you stock-market buyers on "soft landing" hopes: beware. There are always attempts to explain away inverted yield curves, because they always happen way before the economy shows serious signs of weakening. And by the way, this economy is hardly looking solid right now.
Just this week, yet another leading indicator--the Fed's survey of bank loan officers--reported less demand for loans at the end of last year, and tighter lending standards. "We're now at levels broadly consistent with past recessions," wrote Jim Reid of Deutsche Bank, who also uses this data to forecast high-yield credit defaults.
The yield curve's message is not at odds with other leading indicators--it's consistent with them. The fact that employment is still strong is also consistent with how recessions unfold historically; it's often the last place they show up. Jobless claims began an obvious increase just eight weeks before the 2007 recession began; and they are at such low historical levels right now that, unfortunately, the only place left for them to go is up.
And as for hopes that stocks have already bottomed, as Michael Darda of MKM warns, "bear market lows typically occur about two-thirds of the way through a recession."
The only real way out of this, which would harmonize what everyone is saying and hoping for, would be if the Federal Reserve quickly changes course and starts cutting interest rates. Then you might even still be able to achieve a "soft landing," and avoid another leg lower for stocks. Chair Powell even hinted at openness to this last week, which helped ignite equities and is why Feroli thinks a downturn could still be avoided. But the Fed would have to do far more than just hint about it; they'd have to be proactive, now, to really stave it off, and most officials are still out there talking about the need to keep rates "higher for longer."
It may seem odd to cut rates when certain areas of inflation remain sticky and Goldman's economists just slashed their recession odds to 25% this year. But that's because the Fed has to anticipate where we're going up to eighteen months from now! Just because things look better in the near term doesn't mean they aren't about to deteriorate--possibly quite sharply--around the corner.
Remember, recessions occur after the economy has "peaked." And a peak feels like a peak! It feels like the air is clear, and everything is fine--just as the long descent is about to begin.
In fact, as Michael Kantrowitz of Piper Sandler has documented, the very fact that we are seeing so much talk about a "soft landing" itself might be one of the most reliable predictors of recession right now. Previous spikes in "soft landing" news articles on Bloomberg occurred in 2000 and 2006 (see below), just before recessions occurred.
Previous actual soft landings, he adds, occurred when banks were easing lending standards as the Fed hiked rates, which is not the case now.
All of which is to say, don't let this long wait fool you.
See you at 1 p.m!
Kelly
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