You know the moment in a horror movie when the characters are going about their business and nothing bad has happened to them yet, but there seem to be ominous signs everywhere that only you, the viewer, notice?
That’s what watching global financial markets the last couple of weeks has felt like.
In a lot of ways, nothing looks particularly wrong. The S&P 500 was down 0.7 percent Wednesday, tumbling for a second consecutive session, but over all is down only about 5.5 percent from its early May high. The unemployment rate is at a five-decade low. With major companies nearly done releasing their first-quarter results, 76 percent had results above expectations.
But along the way, global bond prices have soared, driving interest rates down sharply. Ten-year Treasury bonds are yielding only 2.26 percent as of Wednesday’s market close, down nearly a full percentage point since November 2018. The outlook for inflation in the years ahead is falling as well, as are the prices of oil and other commodities.
Most significant, the fall in longer-term bond yields has not been matched by a fall in shorter-term rates. For example, a 30-day Treasury bill is yielding 2.35 percent — meaning you can earn more on your money tying it up for a month risk-free than you can tying it up for a full decade.
This is not normal. It is called an inverted yield curve, and historically it has been viewed as a sign of a recession in the offing. At a minimum, it indicates that bond investors believe the Federal Reserve will soon need to cut interest rates — in effect, that it overshot with those four rate increases last year.
There is also a soft underbelly to some of the good economic data of late. Orders for capital goods like business equipment fell 0.9 percent in April, suggesting companies may not be in an expansionary mood. The Institute for Supply Management’s index of activity at manufacturing companies fell sharply in the most recent reading, though it remained in expansion territory.
The financial markets don’t always tell a tidy little story about what is happening, but here’s a theory about reconciling the apparent calm in the economy with the many worrying signs.
The breakdown in trade negotiations with China and the imposition of tariffs on Chinese goods are part of the story, but only a part.
Businesses have weathered escalating tariffs for two years now, and while tariffs can be costly, they do not need to wreck the economy. After all, prices for products fluctuate for all sorts of reasons, and market economies are pretty good at adjusting.
It’s a bird, it’s a plane. No, it’s the President of the United States.
Trump officials continue to express optimism about the commitments that the Chinese made, and what they call a new seriousness from Mr. Xi and his chief economic adviser, Liu He. That is consistent with the message that recent U.S. visitors in private business have told us that they have also heard in Beijing.
But Chinese officials have been notably quiet and unspecific since the weekend about the commitments they made in Argentina. They haven’t even confirmed the 90-day negotiating deadline that Trump officials have stressed. In other words, who’s on first?
Then on Tuesday Mr. Trump belly-flopped into the debate, as he is wont to do. In a Twitter barrage, the President expressed optimism about his weekend meeting and the chances of a deal. But he added that “remember . . . I am a Tariff Man. When people or countries come in to raid the great wealth of our Nation, I want them to pay for the privilege of doing so. It will always be the best way to max out our economic power.” All that was missing was a leotard with a T on the chest and a cape.
Markets apparently didn’t see the super hero humor and promptly sold off. Perhaps they know that tariffs are taxes on commerce, and when you tax something you get less of it. Mr. T’s unveiling also hit on the day after the yield curve on some Treasurys began to invert—which can mean trouble. The economy is still strong enough to survive some uncertainty, but Tariff Man shouldn’t go to war with the laws of economics. He’ll lose.
Investors grow wary as difference between yields on two- and 10-year Treasurys reaches narrowest point since 2007
The gap between short- and long-term Treasury yields is at its narrowest in more than a decade, reflecting investors’ confidence that the Federal Reserve will maintain its current pace of interest-rate increases despite ongoing skepticism about the longer-term outlook for economic growth and inflation.
The difference between the two-year Treasury yield and the 10-year Treasury yield, known on Wall Street as the 2-10 spread, settled Tuesday at 0.428 percentage point, its tightest since 2007. Two-year yields tend to rise along with investor expectations for tighter Fed interest-rate policy, while longer-term yields are more responsive to sentiment about prospects for the economy.
.. John Williams, president of the Federal Reserve Bank of San Francisco said Tuesday in Madrid that while an inverted yield curve is a “very clear symbol that the economy’s about to go into a recession,” some flattening is typical when the Fed raises rates and he doesn’t anticipate an inversion of the yield curve.
.. Some investors are concerned the flattening curve suggests the Fed could raise interest rates more than the economy can handle.
.. On the other hand, higher short-term yields suggest investors have confidence that inflation will reach the Fed’s 2% target, but stable longer-term yields suggest a lack of concern that policy makers will lose control