Economy: 3 Things I’m Starting to Worry About

Today is payday and normally the day I would run a “Payday Links” special, but the economy is starting to flash a number of yellow warning signs in the numbers I check and I thought I’d give a bit of an update. Payday Links will be back on Monday.

There is nothing that is on its own terrifying or scary, but taken together are to me suggesting an economy that is starting to weaken. If these trends continue, 2019 has the look of a year where shit could hit the fan.

Yield Curve Spread Making New Lows

This morning, the 10-year to 2-year yield curve spread on Treasuries is testing new lows at 20 basis points. As this post explains, the yield curve spread is my favorite forward looking indicator, and an inverted spread is associated with very poor equity returns and with economic recessions in the subsequent couple of years. As this chart indicates, nothing in the trajectory of the yield curve spread is deviating materially from a long, slow steady drift towards inversion.

yield curve spread to recession

The ten year treasury itself looked poised to break out to higher rates earlier this month, hitting 3.25%, but it is now back to around 3%. Typically falling longterm rates reflect market expectations of lower inflation and lower economic growth in the future.

Corporate Spreads Are Starting To Widen

This will be known to anyone that invests in a corporate bond fund, but corporate and high yield spreads are starting to widen dramatically. Companies that are not of particularly good credit and are facing bankruptcy are charged higher interest rates on their debt. When the economy is good, the difference between this rate and a benchmark rate such as the US Treasury is quite low, but it widens out very suddenly in front of and during recessions as seen below:

Over the course of the last 2 months, these spreads have widened significantly. It is important to note that a lot of this debt is issued by energy companies, and following oil’s recent drop to near $50/bbl for West Texas Intermediate, these companies have become more stressed. This same activity occurred in 2016. Nevertheless, it is somewhat concerning as layoffs and uncertainty begin to generate the types of conditions which I believe lead to a recession to occur.

Initial Unemployment Claims Are Rising

I will publish a post in the near future about why this metric is relevant, but it is the best contemporary indicator of the economy of which I am aware. This metric reports the number of new individuals that filed for federal unemployment insurance after being laid off from a job. The more layoffs, the weaker GDP gets, the larger this number gets.

At the moment, this number looks to have put in a bottom in September. Whether this is just a temporary floor or the final floor of the cycle obviously remains to be seen. But the upward trajectory of this number is concerning as recessions have never occurred when the number is decreasing.

Conclusion

Taken together, these metrics are consistent with an economy which is beginning to falter. Accordingly I think Mr Powell’s decision with the Fed interest rates this week was probably the correct one and to take the foot off the rate-hike gas pedal a bit. However, I’m not sure if it will be enough. 2019 is looking like a year which could be fairly turbulent, and if I was a betting man I would wager that a recession will begin at some point in the next 2 years.

I’ll keep everyone appraised as things continue to develop.

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