Is A Recession Imminent? (Even If Not, Does It Really Matter?)

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Includes: BBEU, CS, DIA, DXJ, EWJ, EZU, FEZ, FXI, HEDJ, IEUR, IEV, IWM, MCHI, QQQ, SPY, VGK
by: The Fortune Teller
Summary

On one hand, the last nine recessions in the US were all preceded by an inverted yield curve.

On the other hand, the ultimate gauge, that's the 10-2 Year US Treasury Yield Spread, hasn't inverted as of yet.

On one hand, even the one exception to the "yield curve precedes a recession" rule was accompanied by a bear market.

On the other hand, today's inverted yield curve is occurring at lower levels (of benchmark fed funds and yields) than any prior inversion.

The New York Fed's recession model puts the probability of a US recession over the next 12 months at 29%.

The yield curve has inverted again.

Why does this matter so much (or at all)? Because the last nine recessions in the US were all preceded by an inverted yield curve, as measured by the 10-year minus 1-year US Treasury Yield Spread (i.e. 1-year US Treasury Yield > 10-year US Treasury Yield).

Truth is, there are different types of inversions:

1) 10-year minus 2-year US Treasury Yield Spread

To many, that's the most popular, ultimate, indicator.

2) 10-year minus 1-year US Treasury Yield Spread

In this article, we will mostly use/focus on this particular spread.

3) 10-year minus 3-month US Treasury Yield Spread

To put things in the right perspective, here is how the US 10-Year minus 3-Month Treasury Yield Spread has developed along the years:

  • March 2009: 2.43%
  • March 2010: 3.52%
  • March 2011: 3.24%
  • March 2012: 2.28%
  • March 2013: 1.89%
  • March 2014: 2.73%
  • March 2015: 1.92%
  • March 2016: 1.61%
  • March 2017: 1.71%
  • March 2018: 1.08%
  • Today (March 28th): -0.05% (March 2019 = first inversion since August 2007)

As far as I am concerned, the exact spread one is looking at is more of an academic/philosophic debate/importance rather something of essence. When I see such a yield curve (as the one we view these days) - I tend to say that a significant enough inversion has already happened:

Chart Data by YCharts

If history is of any value/guidance, this means that a recession is upon us, with a relatively high probability, soon.

But how "soon" exactly?

If history repeats itself, we could see a recession starting within the next 8-24 months. If we assume that the historical average lead time of 14 months would turn out to be the right time-frame (this time around too), investors should get ready for a recession around May 2020.

An interesting question is: Was there ever an inverted yield curve without a US recession following through? I trust that many readers would be thrilled to know that the answer is Yes!

Between December 1965 to February 1967, the yield curve inverted, without a recession taking place within the following two years. However, before you cheer this exception, it's worthwhile noting that there was a bear market during this period (even without a recession), with the S&P 500 (SPY) declining 24% during February-October 1966.

(Another fun fact related to this period: England won its first, and only, FIFA world cup title in soccer).

How dramatically things have changed over the past year?

One year ago, the US 10-year yield was 2.82%, the US 1-month yield was 1.69%, thus the spread was 1.13%.

Today (March 28th), the US 10-year yield is 2.374%, the US 1-month yield is 2.44%, which means that the spread is -0.066%

Is there anything different about today's inverted yield curve?

Well, yes, actually. It is occurring at lower levels than any prior inversion, when it comes to fed funds rate ("FFR") as well as to 1-10 Year US Treasury Yields.

  • The 1-Year US Treasury Yield, currently at 2.40%, is nowhere near the 6.59% average* yield.
  • The 10-Year US Treasury Yield, currently at 2.44%, is nowhere near the 6.49% average* yield.
  • The FFR, currently at 2.41%, is nowhere near the 6.15% average* rate.

*Based on prior yield-curve inversions.

If a US recession began today, it would be starting at the lowest real FFR (0.3%), i.e. easiest (most loosened) monetary policy of any recession in history.

All in all, those who wish to can find few signs/gauges suggesting there's still hope for the US economy to avoid entering a recession.

Nevertheless, in spite of the markets experiencing the best start to a year since 1987, there are more than enough troubling signs, starting with the yield curve, persistently signalling that danger lies ahead.

Without a worldwide coordination of the macroeconomic policies among the big economic areas - US (SPY, DIA, QQQ, IWM), China (MCHI, FXI), Europe (VGK, EZU, HEDJ, FEZ, IEUR, BBEU, IEV), and Japan (EWJ, DXJ) - it certainly looks as if the risk of entering a big slowdown is imminent, leading to a possible recession.

The New York Fed's recession model puts the probability of a US recession over the next 12 months at 29%. According to Credit Suisse, that's a higher probability than what was reported 12 months before 5 out of the last 7 recessions!

The New York Fed There are more than enough signs to cause us to be much more cautious than we've been over the past few years. It never hurts (too much) to position yourself in a more defensive way, even if that turns out to be a false alarm/move.

At worst, you miss out on some of the additional, potential, upside that the market may go through, if you're proven wrong.

At best, you avoid much of the reversal (to the downside) that the market may go through, if you're proven right.

Stop FOMO ("Fear Of Missing Out") and start FOSI ("Fear Of Staying In"), or better yet - FOGCU = Fear Of Getting Caught Unprepared.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.