An old line about war says that amateurs talk about tactics, but professionals study logistics. A similar line about the economy would be that amateurs talk about stocks, but professionals study the bond market. And lately the bond market is telling a tale of profound pessimism.
Why does the bond market reflect economic expectations? If investors expect a boom, they also expect the Fed to try to rein in the boom by raising short-term interest rates (which it more or less directly controls), to head off potential inflation. The prospect of higher short-term rates then leads to higher long-term rates, because nobody wants to lock money in at a low yield if returns are going up. Conversely, if investors expect a slump, they expect the Fed to cut rates, and pile into long-term bonds to lock in returns while they can.
So the slump in long-term yields since last fall, from a peak of 3.2 percent to just 1.63 percent this morning, says that investors have grown drastically less sanguine about the economy. Long-term rates are now notably lower than short-term rates — and this kind of “yield curve inversion” has in the past consistently been the precursor to recession:
Ominous yieldsFederal Reserve of St. Louis
Bond investors could, of course, be wrong — there are some people out there claiming that we’re in a bond bubble. And so far the real economy, as measured by G.D.P., job growth, and all that, is still chugging along. But as I said, there’s clearly a wave of pessimism sweeping the market. What’s it about?
One answer is that last fall many investors were looking at a couple of quarters of high growth, and thinking that this might be the start of an extended boom. Serious economists warned that this growth was a temporary lift — a “sugar high” — driven by the shift from fiscal austerity to what-me-worry deficit finance. But at least some people bought into the Trumpist line that tax cuts were going to produce an enduring rise in the growth rate.
At the same time, Trump’s trade war may be starting to take a toll. In particular, the uncertainty may be deterring business spending. Whether new tariffs would hurt or help your business, it now makes sense to hold off on plans to expand, until you see what he actually does.
Finally, economic troubles in the rest of the world — several major European economies are quite possibly in recession — are filtering back to the U.S.
Now, most economists aren’t predicting a recession here, for good reason. The truth is that nobody is very good at calling turning points in the economy, and calling a recession before it’s really obvious in the data is much more likely to get you declared a Chicken Little than hailed as a prophet. (Believe me, I know all about it.) But the bond market, which doesn’t worry about such things, is looking remarkably grim. I leave the possible political implications as an exercise for all of you.
Setting the table for a smorgasbord recession.
The last global economic crisis, for all its complex detail, had one big, simple cause: A huge housing and debt bubble had emerged in both the United States and Europe, and it took the world economy down when it deflated.
The previous, milder recession, in 2001, also had a single cause: the bursting of a bubble in technology stocks and investment (remember Pets.com?).
But the slump before that, in 1990-91, was a messier story. It was a smorgasbord recession — a downturn with multiple causes, ranging from the troubles of savings and loan institutions, to a glut of office buildings, to falling military spending at the end of the Cold War.
The best guess is that the next downturn will similarly involve a mix of troubles, rather than one big thing. And over the past few months we’ve started to see how it could happen. It’s by no means certain that a recession is looming, but some of our fears are beginning to come true.
China: Many people, myself included, have been predicting a Chinese crisis for a long time — but it has kept not happening. China’s economy is deeply unbalanced, with too much investment and too little consumer spending; but time and again the government has been able to steer away from the cliff by ramping up construction and ordering banks to make credit ultra-easy.
But has the day of reckoning finally arrived? Given China’s past resilience, it’s hard to feel confident. Still, recent data on Chinese manufacturing look grim.
And trouble in China would have worldwide repercussions. We tend to think of China only as an export juggernaut, but it’s also a huge buyer of goods, especially commodities like soybeans and oil; U.S. farmers and energy producers will be very unhappy if the Chinese economy stalls.