- The yield curve inverted, causing a stock market freak out. Blast Taylor Swift’s You Need to Calm Down when the financial news is on.
- Consumers are still spending, but consumer sentiment is slipping.
- The next inevitable recession is likely to be much shorter and less severe than the Great Recession.
Last week was a week filled with new economic data and financial market volatility.
More than half of the week’s new data point to continued strength and even promising improving trends supportive of growth in the U.S. economy. The other half raises concern.
Retail sales strong: Retail sales were strong in July, as Amazon Prime Day and back-to-school sales boosted online and physical store sales. Permit activity in July point to more new construction later in the year.
Consumer sentiment slips: The biggest concern from last week came from consumer sentiment, which declined in August as a result of stock market volatility and negative trade news. If consumer sentiment declines, consumer spending may follow.
Bond yields decline: Bond yields have declined rapidly in August. The 10-year U.S. Treasury is down nearly 50 basis points since the end of July, but we are not seeing consumers benefitting from lower auto rates. In fact, consumers see vehicle buying conditions worse now than at any point since November 2013.
Vehicle sales strong: We remain confident that with strong fleet sales, new vehicle sales will still reach 16.8 million for the year. As we get one to two years out, a recession and bigger decline in demand will likely occur if these market trends continue.
Yield curve inverts: What freaked more people out last week was the emphasis on the yield curve inversion. Yield curve inversions predict recessions 12 to 24 months out. When the yield curve inverts, lending becomes less profitable for many types of loans with short-term rates higher than long-term rates. So far, the consumer is keeping the U.S. economy in growth mode, but if sentiment keeps dropping and credit tightens, eventually consumer spending will soften. That’s the real worry, but the inversion event last week, doesn’t really mean anything for the near term.
Part of the reason that the market-freak-out wasn’t merited was that the yield curve inversion was not a surprise. The 10-2 spread has been slowly eroding towards zero for five years. Other spreads, like the 10-3 month spread, has been negative since May 21. It was only a matter of time.
This has happened because the global economy is slowing down, which makes the U.S. and our Treasuries more attractive to investors, which drives yields lower and the dollar higher. A higher dollar hurts exports, which makes the trade deficit worse, but that doesn’t help solve our current trade spats.
What does this all mean? A recession becomes more likely over the medium to longer term. But a recession is not a given nor is it imminent. Rates are likely to remain low and possibly get lower as the Fed is forced to further reduce official short-term policy rates to try to get the yield curve “upward sloping.” That would mean the yield curve would no longer be inverted.
The U.S. economy is still growing and is on pace for less than 2% growth this quarter. The consumer is still spending, but if credit tightens and/or lower rates don’t materialize, and consumer confidence declines, growth will be challenged like other major economies are already seeing. The good news is that even if we do slip into a recession, the U.S. does not have major imbalances that lead to harsh corrections. The next recession is likely to be much shorter and less severe than the Great Recession.
We will be watching all key factors closely, but we’ll pay close attention to trade policy, what the Fed does, interest rates, credit access, consumer sentiment, consumer spending, new vehicle sales, used vehicle prices, and home sales.
In the meantime, I suggest blasting Taylor Swift’s You Need to Calm Downwhen the financial news is on.
Looking ahead: This week, we’ll get data on July existing and new home sales and minutes from the July Fed meeting.