Doom and gloom prognostications abound due to the inverted yield curves, which are taken as sure signs of an oncoming recession. At the same time federal debt is at an all-time high as is global debt. US consumers are encumbered with excessive debt as the trade war intensifies with the imposition of more tariffs on goods imported into the US from China. The gold price has risen significantly as investors seek a safe haven for their capital.
The Inverted Yield Curve
There has been a lot written recently about inverted yield curves. A Google search for "inverted yield curve" gave 46,700,000 results while "inverted yield curve recession indicator" gave only 5,940,000 results. There is obviously more than only one yield curve as the yield of any shorter-term security can be compared with the yield of any longer-term security. For Treasury paper at the present time, the yield curve of the three-month bill and the thirty-year bond compares the extremes of the spectrum while the 2s/10s yield curve is considered the main market bellwether.
With so many yield curves inverting, a general alarm has been sounding that a recession is on the way.
What many commentators do not explain is why an inverted yield curve is the herald of a recession. It is a general assumption that longer-term debt is riskier for an investor than short-term debt as future conditions are unknown. The further that debt is projected into the future, the riskier it becomes. Therefore long-term debt should have a higher return than short-term debt. When investors fear a downturn, they will shift capital from equities to bonds in order to hedge against a stock market downturn. The demand for bonds increases, which results in higher prices for bonds in the secondary market. When the price of a bond increases, the yield decreases. When there is strong demand for long-term fixed income paper, the yield of long-term bonds or notes decreases as investors want to lock in a higher yield by buying long-term fixed-income securities. The conclusion is that an inverted yield curve signals the approach of a recession because investors fear an economic downturn and shift capital from equities to bonds. An inverted yield curve therefore indicates a change in market sentiment. This factor can contribute towards bringing on a recession.
There is still another factor that should be taken into consideration. The yield curves of US Treasury paper can be influenced by foreign investment. With the fed funds rate at 2%-2.5% US government funds yield more than what almost all other central banks have to offer. The result is that foreign capital flows into the US and ends up in Treasuries, thereby pushing up the price and pushing down yields.
Exceedingly High Debt
It has been shown by academic research that high debt hampers growth. Debt in the US is at extremely high levels. The US debt clock
indicates that the federal debt is over $22.5 trillion. Student debt is over $ 1.5 trillion while credit card debt is over $ 1 trillion. These latter debt levels indicate that consumers are highly indebted and that growth in the US economy, which depends about 70% on consumption, is going to be limited. The number of defaults on auto loans and that of personal bankruptcies are also indicators that consumers are struggling to pay their bills. This does not apply to the upper 10% of the population, which is still well off. It is the other 90% that is not going to fuel the economy. This situation is due to the wealth gap that has widened excessively in the last few decades.
The amount of debt globally has also increased in the last few years. The IMF data mapper and chart shows this clearly.
The Trade War with China
The imposition of tariffs on goods imported from China will impact the bottom 50% of income earners the most since higher prices for many goods will be passed on to consumers at a certain point. Even if the Chinese currency weakens against the US dollar, tariffs of 25% to 30% are not going to be absorbed completely by a cheaper renminbi.
The trade war will also aid and abet the global slowdown already in progress. This has been noted by Lance Roberts in a good article about the threat of a recession (Technically Speaking: Market Risk Is Rising As Retail Sends Warning).
The UBS outlook is also not very positive.
The Gold Price
The price of gold has risen. This indicates that gold is in a bull market and investors are looking for safe havens.
The yield curves indicate a recession will set in within 12 to 18 months. Debt is extremely high. That includes federal, corporate and personal debt. The trade war shows no sign of ending soon. The price of gold has increased significantly since June.
Investor sentiment has changed with investors buying bonds to hedge against downturns in the equity markets. The sharp rise in gold corroborates this assessment of the situation. It is therefore prudent to take gains in equities at the present time, weed out losers and position one`s portfolio defensively. There may still be a stock rally before the downturn, but it is better to be prepared for the turmoil that is ahead. Recent stock market volatility with sharp shifts up and down are harbingers of worse things to come just like minor tremors can presage a strong earthquake. Semper paratus (Always ready), the motto of the US Coast Guard, should also be the motto of every investor.
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