YC Has Perfect Batting Average Going Into the All-Star Game
The yield curve (YC) has a perfect record since 1955!
Will it affect the next presidential election?
The MLB All-Star game is one week from today. No player in history has ever had a perfect batting average at the All-Star break. No one. Ever.
The yield curve has been in the game since 1955 and has “correctly signaled all nine recessions since 1955 and had only one false positive, in the mid-1960s, when an inversion was followed by an economic slowdown but not an official recession,” according to the Federal Reserve Bank[i]. A perfect record predicting recessions. Sounds like it might be worth knowing about.
See the red line below and how it is flatter than the others, in particular the yellow line? The yellow line shows rates as they were a year ago and is a normal yield curve meaning longer term bonds pay more interest than shorter term bonds. The red line is the current yield curve. Short term rates on the left side of the line have increased significantly while long-term rates have remained nearly constant. The curve is flattening. When the left side of the line rises above the right side, the yield curve is then inverted.
Economists focus mostly on the spread between the 2-year US Treasury and the 10-year US Treasury to define an inversion. Here’s what the yield curve looked like at this time in 2006, two years before the Great Recession invited us to the party. Notice how the red line dips slightly from the 2-year mark to the 10-year mark? That is the classic definition of an inverted yield curve.
What makes the yield curve move?
In short: The Fed. The Federal Reserve Bank sets one rate and one rate only: the Federal Reserve Bank Discount Rate. Until 2008 banks rarely used the Fed “Discount Window” so the rate was purely academic – except for the fact that is drives the global macroeconomy. That’s right – nearly all economic activity globally takes its signal from this one obscure rate that historically has rarely been used.
The “Great Recession” was triggered by the Fed raising the Discount Rate 17 times, 25 basis points or 0.25% at every Fed Meeting or every other meeting for two years. This is what it looked like:
Then the Great Recession “hit” and the Fed raced to lower rates then held them at record low levels:
Notice how rates remained low for nearly a decade? And now are marching back upward? The Fed meets July 31, September 25, November 7 and December 18 this year. Four more opportunities to increase the Discount Rate on top of the seven increases in the last two years:
The minutes from last Fed meeting in May 2018 reveal the Fed’s thoughts on the direction of interest rates:
“It would likely soon be appropriate for the Committee to take another step in removing policy accommodation”
Translation: We are increasing interest rates
The Fed pushes the short end of the yield curve up and if macroeconomic conditions do not cause long term rates to rise in sync, a recession results. Long term rates are not rising so a couple more Fed rate hikes should be all it takes to invert the yield curve. And given the one to two year precursor effect of an inverted yield curve, the timing of the next recession is likely to coincide with the next presidential election cycle. What fun!
Test on this on Friday.
What does this mean for you?
Adjust your company’s spending, hiring and investment plans now while you still have time to plan. Planning on building a new plant to double output? Might want to put that on the back burner.
Consumer discretionary spending usually declines in a recession as does business spending. Hiring and expansion get put on hold and employers lay off employees. Banks tighten up lending because they can’t make as much on long-term loans as they can on short-term loans. Mortgage lending decreases because home buyers have to pay a higher mortgage payment as a result of higher interest rates. Riskier assets tend to get punished disproportionately. Anything in an oversupply condition will be especially hard hit – excess inventory gets extremely hard to move. On the other hand, less expensive consumer discretionary alternatives typically outperform during recessions. Going to the movies is much cheaper than a European or beach vacation. Alcohol sales also tend to trend up. Maybe the cannabis legal states will see an uptick, who knows, it’s possible.
Most important: Call Vertical Capital Advisors. We will harmonize your business plan and strategies with the market.
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