Inversions Widen
Today’s bond market action is a strong follow-through on Friday’s action.
Imminent Signal
The recession imminent signal is not the inversion but a sudden steepening of the curve following a period of inversion.
A comparison of the strength of the inversions today vs 2007 will show what I mean.
Inversions With the 3-Month Note Today
The 10-year, 7-year, 5-year, 3-year, and 1-year notes are inverted with the 3-month T-Bill. The inversion isn’t the signal. A sudden steepening of the yield curve following inversion is the “recession imminent” signal.
Inversions With the 3-Month Note 2007
Chart 1 Repeated for Ease in Reading
Signal Discussion
- Box 1, Box 4, and Box 5 all have the same thing in common: A sudden steepening of the 3-Month to 10-Year and 2-year to 10-Year curve following inversion.
- Box 2 had no inversions
- Box 2 and Box 3 show a steepening of the 3-month to 10-year spread but not the 2-year to 10-year spread.
Some are waiting for a 2-10 inversion. Perhaps it does not happen. But even if it does, that will not be the signal.
Watch for a sudden steepening of the curve following an inversion.
How? Why?
That’s easy. The Fed will either cut or signal it is about to cut.
Too Late
On August 17, the Fed Cut the Discount Rate by 50 Basis Points
Fed Statement: Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.
Flashback September 18, 2007
Inquiring minds are investigating the Minutes of the August 7, 2007 FOMC meeting released September 18, 2007.
Amazingly Wrong Points
- At its August meeting, the FOMC decided to maintain its target for the federal funds rate at 5-1/4 percent. In the statement, the Committee acknowledged that financial markets had been volatile in recent weeks, credit conditions had become tighter for some households and businesses, and the housing correction was ongoing. The Committee reiterated its view that the economy seemed likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.
- Conditions in corporate credit markets were mixed. Investment- and speculative-grade corporate bond spreads edged up; they were near their highest levels in four years, although they remained far below the peaks seen in mid-2002
- In preparation for this meeting, the staff continued to estimate that real GDP increased at a moderate rate in the third quarter. However, the staff marked down the fourth-quarter forecast, reflecting a judgment that the recent financial turbulence would impose restraint on economic activity in coming months, particularly in the housing sector. The staff also trimmed its forecast of real GDP growth in 2008 and anticipated a modest increase in unemployment.
- With credit markets expected to largely recover over coming quarters, growth of real GDP was projected to firm in 2009 to a pace a bit above the rate of growth of its potential.
- Participants thought that the most likely prospect was for consumer expenditures to continue to expand at a moderate pace on average over coming quarters, supported by growth in employment and income.
- In the Committee’s discussion of policy for the intermeeting period, all members favored an easing of the stance of monetary policy. The Committee agreed that the statement to be released after the meeting should indicate that the outlook for economic growth had shifted appreciably since the Committee’s last regular meeting but that the 50 basis point easing in policy should help to promote moderate growth over time.
Yield Curve Reaction
The Fed did not reduce the Fed’s fund rate. So, why did the yield curve react?
The Fed did slash the discount rate by 50 basis points. The yield curve reacted sharply.
If you think the Fed has a handle on stopping the next recession think again.
As in 2007, they will not even see it. Nor would they admit it if they did.
Watch for Steepening
Watch for a sudden steeping of spreads. Don’t expect a long warning period, and don’t pay attention to the Fed or president Trump yapping about the strong economy when it happens.
I expect the delay this time may be negative, the recession will already have started.
Miracles Not Coming
The Fed blew another magnificent bubble.
Don’t expect miracles. The next recession is baked in the cake.
Correction: I inadvertently switched comments for box 2 and box 3, now fixed.
Mike “Mish” Shedlock
After a decade of low rates all we has was a weak economy , a crack hit from a tax cut and now we go back to a weak economy. Problem is corporate bond resets are baked in. Rate cuts are coming but wont save anything. The federal budget is going to get crushed.
Correction: I inadvertently switched comments for box 2 and box 3, now fixed.
“”Box 2 and Box 3 show a steepening of the 2-year to 10-year spread but not the 3-month to 10-year spread.” I think this is switched.”
Good catch
I inadvertently switched my comments
“Box 2 and Box 3 show a steepening of the 2-year to 10-year spread but not the 3-month to 10-year spread.” I think this is switched. The blue lines did steeply rise for box 2 and 3 and the blue lines are the 3-month to 10-year. ???????
To appreciate the task of the Fed, consider driving a car down the highway. It’s not a difficult task, because when you look out, you can see where you are, and where you are going, and when you turn the steering wheel, something happens immediately and the direction changes.
Now lets say that you can no longer look out. Instead, to determine your current position, you are given some vague statistics that sort of tell you where you are…or, perhaps, where you might be, and sort of which direction you might be going. Next, let’s add some delay in the steering mechanism, so that when you turn the wheel, nothing happens right away, but some months later, your course has been slightly altered, in one direction or the other.
Could you keep on the road that way? I know I couldn’t, and I doubt anyone could. That’s why Milton Friedman used to argue that it was futile to even try. Instead, he argued, the Fed should be content to focus on an orderly expansion of the money supply, and quit trying to do the impossible, micro-manage the economy.
“Milton Friedman…argued…the Fed should be content to focus on an orderly expansion of the money…”
Did Milton ever explain why the money supply ought to be “expanded”?
By the way, I love the word “orderly”, as in “Let’s orderly counterfeit the money, so we can make more money!”
As the economy expands, the money supply needs to expand with it. Even those that back a gold standard recognize that. The supply of gold expands every year as new gold gets mined. Nevertheless, the rate at which it expands is controlled, though at times of major gold discoveries, the rate at which it expands can vary.
“the money supply needs to expand with it” Why?
In answer, the economy, I’m sure would adapt, but it might be traumatic at first. Obviously, the first thing would be that deflation would begin. As people because to hoard the money, less would be available to circulate, thus decreasing velocity. Since GDP=Money supply*velocity, if the money supply were constant, and velocity fell, that would mean a shrinking GDP. The only way an economy can grow while constrained by a fixed money supply is if velocity grows, but when money supply is fixed, it encourages exactly the opposite.
In a deflationary environment, depending on the rate of deflation, businesses would have to adapt (which they could do), and give their employees an annual review and pay cut, or if deflation was bad enough, perhaps more frequently, say a pay cut every 90 days. Things like the minimum wage would have to go away, however, to facilitate this, or businesses would be crushed between falling revenues and a fixed wage.
The free market, if left unfettered, will find a way to adapt and thrive in any environment. Some environments, however, involve a lot more turbulence than others. If the money supply grows at the same rate as the economy, you have neither inflation nor deflation. That was exactly why the gold standard has been popular for thousands of years. The gold supply grew at about the same rate as the economy.
I think you are right, prices would go down over time if money did not increase (assuming increasing productivity). Wouldn’t that really mean that interest on savings would be built right into the system? That actually seems intuitive to me. Unlike the insanity we have now, where one’s “savings” shrink over time despite the so-called “strong” economy.
Yes, prices would go down, and savings would be built in. There are some benefits to that – it encourages thrift, and delaying spending. On the other hand, any system is going to have problems, just different ones than we have now. The biggest concern is that if the constriction in money supply constrained the economy and prevented it from growing, GDP/person would fall, as would the standard of living. Those that have money would benefit, and those that don’t would suffer.
I think that history has shown that the best system is one where the money supply grows at the same rate as the economy. Then you have neither inflation, nor deflation, and neither a constriction on the economy, not a tendency to create bubbles.
“The biggest concern is that if the constriction in money supply constrained the economy and prevented it from growing, GDP/person would fall, as would the standard of living. Those that have money would benefit, and those that don’t would suffer.”
If the money supply starts to get restricted, then (in a fair market) bankers would respond by increasing the rate at which they rent it to attract more of it for them to rent out (at a higher rate, obviously) – problem solved. If the purchasing power of the currency increases to an extreme, then the currency can always be further denominated. Remember when a penny could buy something? “Expanding the money supply” and “protecting against a liquidity crisis” is just cover for stealing the currency’s purchasing power and robbing savers of making money off their prudence.
Inflating the currency has next to NOTHING to do with increasing the standard of living. The geniuses of Bill Gates, Steve Jobs, and other inventors/doctors/scientist/engineers, etc. were NOT the result of a thieving monetary policy.
Don’t buy the hype Carl_R!
Thanks.
“If the money supply starts to get restricted, then (in a fair market) bankers would respond by increasing the rate at which they rent it to attract more of it for them to rent out (at a higher rate, obviously) – problem solved.”
Thanks for making my point for me, Dan. That is exactly what would happen. That would mean very high real interest rates even as there is deflation, which would squeeze any potential for growth from the economy. The bankers would get richer, until their debtors were bled dry, and ended up bankrupt. As I said above, those that have money get richer, and those that don’t get poorer.
The reason the gold standard has worked well for thousands of years is that typically the supply of gold increases at about 1-2% a year, which is about the rate of expansion of the economy. Thus, their is neither inflation, nor deflation, but rather a steady, honest economy.
Additional questions: What would happen to the purchasing power of the existing dollars if the money supply was not allowed to expand and would this effect be bad for those holding existing dollars?
I think the issue is not whether the numerical level of prices change over time, which is by itself just a technical effect that should not really matter. The important thing is that the connection between real wealth, productivity, and private property maintains. So it doesn’t matter if the number of grams of gold I get paid per year goes down over time, that in itself is not bad. The important thing is that the purchasing power of my income should be going up concomitantly with both the increase in my own productivity and the productivity throughout the real economy. We of course see snippets of this behavior, such as: a couple of weeks of a modest salary in 1984 would buy you a Commodore 64; 35 years later the same will buy you a pocket-sized super computer. In a healthy economy, that growing-wealth effect would apply across the board, not just to tech gadgets. But instead we see housing, labor, health care, etc becoming more and more unaffordable, and the have-nots may have sweet smartphones but they are losing financial ground. (I actually think much of the top 10% are losing ground too, they just don’t know it yet because they assume the bubbly numbers on their computer screens are real wealth.)
If, as you say, it is important that the money supply grow at the same rate as the economy, I’d ask: how important is it, and how accurate must those rates match? What if the money supply is growing at 1%, and the economy is growing at 5% — is that “bad” and eventually going to blow up? Well, how in the world could the money supply ever match exactly the growth of the economy (which is a problematic concept anyway)? … I suspect that whole line of concern comes from conflating currency with real wealth, capital, and productivity.
If the money supply grows at a different rate than the economy, you get either inflation or deflation. You aren’t every going to match exactly, so you will always have some of one or the other. A small amount of either is not a big deal, but what you don’t want is a large amount of either as they create disruptions in the form of non-productive activity as people try to take advantage of it.
Getting back to my original statement, if the Fed contented itself with allowing a 2% a year increase in the money supply instead of trying to manage interest rates, and instead of worrying about recessions, etc, then the monetary system would mimick what happens under a gold standard. It isn’t going to happen, but it’s a nice thought.
“It will be a big, beautiful recession. Very big and beautiful.”
So basically what Mish and others are saying is that the US economy is unable to prosper/grow with a real rate of interest over 0%. How sad is that? I’m sad that the Fed did not have the ****s to hike up to 4% and put the unicorns and zombies under once and for all. No pain, no gain but at least Granny will have some interest money to buy cat food.
I’m sure there will be a recession at some point and when we look back it will be obvious from some indicator.
Not sure what steps I would take if I knew it was coming in 3 -6 months. Kind of looks like there is no place to hide.
QE to infinity and beyond…or bust. No surprise that we arrived here in this situation. It was folly from the beginning to think we could pour all of that liquidity into a corrupt financial system and produce a sustainable recovery.
Irrefutable science.
Capital flight can’t find a parking place in the only growth story on the planet.
What growth story? No country is an island in the 21st century globalized World. US can kick around but cannot escape the inevitable. Will join with the rest of the global recession!
Debt on debt cannot remain a panacea for all the financial problems (public/private) all over the world. Amount debt is on record on any and every kind, unlike any time in human history!
Reversion to the mean is on it’s way!
Hi Sunny,
I posted a link to growth and pending growth, but Mish removed it. Please do a Google news search for the word ‘reshoring’. I get twenty thousand positive growth hits.
We share the same opinion on debt. The global debt collapse underway and coincident deflation pressure could be good for cost of living and could be bad for employment. We are at an inflection point one direction or the other.
Speaking of inflection point, as Menaquinone says, there’s a patented equation by a former geophysicist turned economist, Didier Sornette, that predicts “something” will happen (inflection) in the year 2050, if you feed the equation data (the same equation is used to ‘predict’, roughly, earthquakes). Coincidentally (or not?) the year 2050 is when world populations peak. If you believe capitalism is largely extensive growth rather than intensive growth (Google this, basically the former is ‘dumb growth’ from people being born, consuming, then dying, the latter is ‘smart growth’ like inventors inventing a new widget), and if demographics is destiny, then the next 30 years will see “interesting times”. When and if ‘the big one’ hits, an economic catastrophe of 9.9 on the Richter Scale, the downside will be legion. The upside? FINALLY, Money magazine will cease publication and the “buy on dips” mentality will go extinct!
Re shoring doesn’t address the humongous problem of record (private/public) debt. Global debt/GDP 250T/100T!
The growing interest payment on the growing national debt (22T++) may exceed the budget of Defense within 2-3 yrs!
If the Govt takes away the resources necessary for private-productive economy, the future for young Americans won’t look that good.
This is what the criminal Fed/CBers have done immense damage to the global economy, by insane credit infusion for short term benefits. I hope I am wrong!
Time for some new Fed Buzz words… the old ones will just stir up anger. Hopefully the new ones won’t get by the American people.
So basically the Fed Meeting, June 19?
Which gurantees a tsunami of fresh money printing,DC will need to borrow 3-4 trillion this year……just to avoid default (good luck with that)and a massive 5 trillion in red ink next year,Can the fed print all that cash on the down low and shove into stocks and bonds without detonating the dollar…….not a chance!
Well said although sadly we’ll, the US, prob still be the cleanest shirt in the bag of dirty laundry and this game will go on much longer than what we all expect in our wildest dreams.
US $ is where the money will be parked during any market/ global up heavel. Just look at the previous bear mkts. 10y yield could be below 2% by the end of the year if not sooner!
Trump is playing 4-D chase with the whole world. Only fake news media are seeing recession upcoming.
That was a dumb statement… especially since you never even tried to refute the evidence presented.
I cannot tell if that was sarcasm or silliness
lmao. Im reading sarcasm there. I hope.
The usual projection of attention-seeking nonsense. He gave them a stunted vocabulary, they gave him undying loyalty. They’re all coming up short.