- The yield curve inverting was the biggest story in the last 12 months.
- The global economy seems to be regaining its footing.
- A blockbuster housing data point should be a catalyst in 2020.
- Looking for a helping hand in the market? Members of The Lead-Lag Report get exclusive ideas and guidance to navigate any climate. Get started today »
Stocks historically return more than almost all other alternative investments, but only when priced right when the race begins. - Bill Gross
Remember when the yield curve inverting was in the headlines every day? You couldn't have your morning coffee without someone mentioning it, and every time the indicator worsened, the market would whipsaw. It is true that a yield curve has predicted every recession since 1950. But it is also true that an inversion of the yield curve has not always been a reliable indicator. There have been two false positives, one in 1965 and another in 1998, according to JPMorgan Asset Management.
Given the lack of data points, one could easily posit that the indicator that is so widely assumed to be accurate, is not. There certainly hasn't been enough data points to consider it statistically relevant, and many other things have to happen (or not happen) after inversion for a recession to hit, as clearly indicated by the other 2 false positives, and possibly the most recent inversion in 2019. The move this year, we think, isn't necessarily a predictor of gloom. While it was the first time that very short-term yields traded above longer-term maturities in this expansion, the Fed was able to correct this by lowering short-term rates, moving the curve out of inversion. The current yield curve now sits at its steepest level for the year, in a normal un-inverted manner.
So, what is the biggest thing that the inverted yield curve needs to be a reliable predictor of a recession? The Fed. Taking a look at the two examples of inversion that did not lead to a recession, and the others that did, the Fed was the most glaring difference. For the recessionary examples, the Fed was hiking rates, tightening monetary policy into the inversion. In the non-recessionary examples, the Fed was lowering rates, stimulating the economy by loosening monetary policy. While the Fed was hiking back in 2018, they have clearly been on an easing path in the last year and have clearly stated they intend to remain neutral until inflation comes back into the economy, as stated in the Lead-Lag report last week.
It is worth stating again: Yield curve inversions are a reliable predictor of recessions when the Fed tightens into and out of an inversion. That circumstance does not apply to 2019, as the Fed cut rates 3 times this year. We've also started to see the long end of the yield curve, namely the 10-year treasury rate, start to increase off the bottom - we think it will break 2% in 2020 easily and potentially, look at 3% if things go really well.
One of the things that is helping the recent surge is the recovery of the global economy, along with trade tensions easing. U.S. business activity maintained a 5-month high on Monday, and Chinese data is improving - industrial output and consumer spending accelerated throughout November. Better-than-expected data like this, along with a limited trade deal and further constructive trade talks, could alleviate many concerns about global growth in 2020. We saw this in some forecasts as well, with economists at UBS and Oxford Economics raising their 2020 Chinese growth to 6% from 5.7%. Of course, these projections all come with a degree of uncertainty, with risks from the Chinese cooling property sector and the potential for trade talks to break down, but if the world's largest two economies in the U.S. and China are growing at a healthy clip, it will be hard to discount the carryover affect the rest of the global economy.
This article was written by Michael A. Gayed. An author on Seeking Alpha and founder of the Lead Lag Report.
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