Mind the No. 9 Slope
Ignore the Negative Yield Curve at Your Peril
The real problem with predicting a soft economic landing, where we zip past a recession, or a hard one that leaves us clobbered on the slopes, is that at the start of the run, both scenarios look exactly alike.
Are we on the delightful and mildly challenging bunny slope where rate hikes squeeze a bit until investors price in the future in time for the stock market to peak and deliver a sustained bull market? Or, and bear with me, is the economy hurtling down an unforgiving black diamond slope that’s going to end with a broken femur as employment weakens and everyone gets spooked enough to become hoarders?
Well, most of the gossip on the lift was about the strong jobs data and consumer spending. It is, in fact, suspiciously good – at least Jay Powell seems to think so. Of course, it’s possible that a monetary overhang of stimulus that created the glut of household savings will be absorbed, inflation will go away on its own, and all will return to normal in time for the big rally. It’s a popular theory, and because all news is squeezed through the progressive diaper these days, there is even a measure of social justice sneering at a quote “white-collar” recession contained to corporate execs, bankers and Silicon Valley sorts. The satisfaction may be short-lived: How long will the labor market for restaurants, warehouses, and construction stay tight when said white collars stop eating out and buying all sorts of crap they don’t need, including yet to be built houses?
How optimistic you are that the economy will end the run briskly invigorated at the lodge with a glass of kümmel in hand – or be medevaced off the side of a mountain – depends largely on which market you’re watching for clues. The sexy volatile stock market might give you hope for a soft landing, but the much larger bond market has wipeout written all over it. Unfortunately for the optimists, bonds have a much better track record in predicting which path an economic scenario might follow – whether you like it or not.
Take, for instance, the gap between the 10 year and three-month Treasury yields. The yield curve on a graph should be upward sloping (positive) because investors want more return in order to keep their money tied up for longer periods. And it usually is. At the moment, however, that yield curve has taken a nasty downward (negative) slope. Meaning that investors, betting on imminent and sustained rate cuts, are buying longer Treasuries at today’s higher rates, upping their price and driving down their yields. Or more to the point, it points to a wipe out.
Granted, stock market investors are right most of the time, meaning better than half. But they’ve been wrong a lot lately and are fairly jumpy. In the less sophisticated corners they tend to listen to Jim Cramer and or put their money into cryptos and meme-stocks their IT guy told them about.
The bond market, on the other hand is boring operates on a scale also that equities markets can’t hope for. It has a much better record when calling what is around the next bend. The yield curve has gone the wrong way nine times in the last 50 or so years. Eight of these times were followed by a recession, the hard landing.
As for number nine? That’s the slope we’re hurtling down right now.