The dominos are wobbling – The recession indicators are at a tipping point
I don’t know how to play dominos, but as a child it was always fun to line them up, then knock the first one over and watch the chain reaction. Today, the domino effect is a perfect way to explain how we think recession signals fall into place.
The Slope of the Yield Curve
The first domino is wobbling, yet it hasn’t toppled over. The slope of the yield curve – this critical measure of the difference between two-year and 10-year treasury rates – has inverted (10-year below two-year) well in advance of every recession in U.S. history. The slope recently inverted momentarily, but has since maintained a positive slope.
History tells us the inversion needs to be sustained for several weeks before it becomes a signal. Different slopes have already inverted – for example, the Fed Funds to 10-year treasury rates has been inverted since May. At that time, some pundits declared a recession is near. We think the signal is the two-year to 10-year slope inversion and clearly this domino is wobbling. Once the two-year to 10-year slope sustains an inversion, a recession is on average 14 months away.
Making an economic forecast based on just one variable will more than likely lead to an erroneous outlook. The slope of the yield curve has a perfect track record in predicting recessions. However, it is worth noting that historically, when the slope inverts, the Fed is raising rates. In this situation, the Fed essentially inverts the curve. Today, the situation is different, as the Fed is cutting rates.
Leading Economic Indicator Index
The second domino is the Leading Economic Indicator Index (LEI). LEI is an index comprised of 10 leading indicators: seven non-financial and three financial. The six-month rate of change in the LEI index has an excellent track record of predicting inflection points in the business cycle. A rate of change of -3% or less indicates an oncoming recession.
Today, the six-month rate of change is 0.4%, a level experienced in 2012 and 2016, when there was not a looming recession. A -3% reading was seen in August 2000 and in August 2007, right before recessions. Once LEI’s six-month rate of change hits -3%, on average a recession is 10 months away. Currently, this domino stands tall, without even a wobble…yet.
Initial unemployment claims have spiked above 300,000 in advance of every recession in recent decades. Currently, jobless claims are incredibly low – grinding their way steadily down to a recent four-week average of only 213,000, the lowest reading in nearly 50 years.
Intuitively, it is difficult to go into a recession when everyone is gainfully employed. Typically, claims bottom an average of 11 months before the onset of a recession. And after they bottom, they don’t just move higher, they spike higher. Today, there’s no sign of even a bottom.
The Federal Open Market Committee finds themselves in a difficult situation. As outlined above, economic variables are not pointing toward an impending slowdown or recession. The first domino (Treasury slope) has yet to fall, and several need to be falling before we can have any certainty that a slowdown is headed our way.
However, the financial markets are putting enormous pressure on the Fed to move rates substantially lower to help ensure that the economy stays on strong footing. Just a few months ago, the Fed was steadfast in their intention to gently ratchet rates higher – back to more “normalized” levels. However, pressures from the financial markets and turbulence from the U.S./China trade negotiations have caused a rapid reversal in Fed strategy and rates are now headed lower. Additionally, rates are near zero (or lower) in Japan and Europe – a situation that exacerbates the markets’ demands for lower rates.
Recent dramatic swings in both stock and bond markets are increasing the likelihood that the Fed will cut rates again in September, perhaps by as much as 50 basis points. Our economic variables don’t clearly support the case for lower rates, but market realities have pushed us into a “lower for longer” cycle.
A 50 basis-point cut (to 1.75%) would likely be viewed as aggressive and should help calm the markets. This should give the Fed time to go into “wait and see” mode, assessing whether any economic dominoes are set to tumble. We believe that overnight rates will finish the year at 1.75%, and that this will be low enough to calm the markets and keep the economy moving at a reasonable pace. Rates are likely to stay very low (around 1.50 – 1.75%) and very flat for the foreseeable future.
The Domino Effect
If history is any guide, recession signals are triggered just like a domino’s fall. The slope of the yield curve domino is wobbling; it may or may not tumble. However, before we call for a recession, we will wait for other dominos to fall.
There is a disconnect between the economic fundamentals and interest rates. UMB’s GDP forecast is 2.3% for 2019 and 2.0% for 2020. Fed Funds are anticipated to move lower though out the year, not due to required economic stimulus, but rather due to virtually zero interest rates around the world.
Join the UMB Investment Management team on Aug. 21 from 10-11 a.m. CT as they share their insights on the current market environment. Chief Investment Officer KC Mathews will lead a discussion covering recent market moves and how to interpret them, register now.
To stay informed of the latest market trends, sign-up to receive economic updates and follow UMB and KC Mathews on LinkedIn. Interested in learning more about our Private Wealth Management division? See what we mean when we say, “Your story. Our focus.”
When you click links marked with the “‡” symbol, you will leave UMB’s website and go to websites that are not controlled by or affiliated with UMB. We have provided these links for your convenience. However, we do not endorse or guarantee any products or services you may view on other sites. Other websites may not follow the same privacy policies and security procedures that UMB does, so please review their policies and procedures carefully.
DISCLOSURE AND IMPORTANT CONSIDERATIONS
UMB Investment Management is a division within UMB Bank, n.a. that manages active portfolios for employee benefit plans, endowments and foundations, fiduciary accounts and individuals. UMB Financial Services, Inc.* is a wholly owned subsidiary of UMB Financial Corporation and an affiliate of UMB Bank, n.a. UMB Bank, n.a., is a subsidiary of UMB Financial Corporation.
This report is provided for informational purposes only and contains no investment advice or recommendations to buy or sell any specific securities. Statements in this report are based on the opinions of UMB Investment Management and the information available at the time this report was published.
All opinions represent UMB Investment Management’s judgments as of the date of this report and are subject to change at any time without notice. You should not use this report as a substitute for your own judgment, and you should consult professional advisors before making any tax, legal, financial planning or investment decisions. This report contains no investment recommendations and you should not interpret the statements in this report as investment, tax, legal, or financial planning advice. UMB Investment Management obtained information used in this report from third-party sources it believes to be reliable, but this information is not necessarily comprehensive and UMB Investment Management does not guarantee that it is accurate.
All investments involve risk, including the possible loss of principal. Past performance is no guarantee of future results. Neither UMB Investment Management nor its affiliates, directors, officers, employees or agents accepts any liability for any loss or damage arising out of your use of all or any part of this report.
“UMB” – Reg. U.S. Pat. & Tm. Off. Copyright © 2018. UMB Financial Corporation. All Rights Reserved.
* Securities offered through UMB Financial Services, Inc. Member FINRA, SIPC or the Investment Banking Division of UMB Bank, n.a.
Insurance products offered through UMB Insurance Inc.
You may not have an account with all of these entities.
Contact your UMB representative if you have any questions.
SECURITIES AND INSURANCE PRODUCTS ARE:
NOT FDIC INSURED • NO BANK GUARANTEE • NOT A DEPOSIT • NOT INSURED BY ANY GOVERNMENT AGENCY • MAY LOSE VALUE
- January 2020
- December 2019
- November 2019
- October 2019
- September 2019
- August 2019
- July 2019
- June 2019
- May 2019
- April 2019
- March 2019
- February 2019
- January 2019
- December 2018
- November 2018
- October 2018
- September 2018
- August 2018
- July 2018
- June 2018
- May 2018
- April 2018
- March 2018
- February 2018
- January 2018
- December 2017
- November 2017
- October 2017
- September 2017
- August 2017
- July 2017
- June 2017
- May 2017
- April 2017
- March 2017
- February 2017
- January 2017
- November 2016
- October 2016
- September 2016
- August 2016
- July 2016
- June 2016
- April 2016
- January 2016
- October 2015
- September 2015