Breaking News
Get 40% Off 0
Is NVDA a 🟢 buy or 🔴 sell? Unlock Now

Yield Curve Keeps Sending Message Investors Should Not Ignore

By Lance RobertsMarket OverviewSep 29, 2023 06:12AM ET
www.investing.com/analysis/yield-curve-keeps-sending-message-investors-should-not-ignore-200642264?fbclid=IwAR2E4WbEWV_vB-LirixviNwB267tGHbElUceta0OPFAXxmJ-k_fpxAwbOUQ
Yield Curve Keeps Sending Message Investors Should Not Ignore
By Lance Roberts   |  Sep 29, 2023 06:12AM ET
Saved. See Saved Items.
This article has already been saved in your Saved Items
 
 
US500
-0.38%
Add to/Remove from Watchlist
Add to Watchlist
Add Position

Position added successfully to:

Please name your holdings portfolio
 

The Fed’s “soft landing” hopes are likely overly optimistic. Such was the context of our recent report, which discussed the long record of the Fed’s economic growth projections. To wit:

“However, there is a problem with the Fed projections. They are historically the worst economic forecasters ever. We have tracked the median point of the Fed projections since 2011, and they have yet to be accurate. The table and chart show that Fed projections are always inherently overly optimistic.

As shown, in 2022, the Fed thought 2022 growth would be near 3%. That has been revised down to just 2.2% currently and will likely be lower by year-end.”

FOMC Economic Projections
FOMC Economic Projections

As we noted, the Fed’s outlook for more robust growth allowed them to keep one rate hike on the table. While the prospect of further rate hikes spooked the stock and bond markets immediately following the announcement, as we discussed, such was needed to keep markets in line.

The Fed projecting one last rate increase is also a way of preventing investors from immediately turning to the next question: When will the Fed cut? The risk is that as soon as investors start doing that, rate expectations will come down sharply, and with them, long-term interest rates, providing the economy with a boost the Fed doesn’t want it to receive just yet.

That is right. Since October last year, the market has been hoping for rate cuts and increasing asset prices in advance. Of course, higher asset prices boost consumer confidence, potentially keeping inflationary pressures elevated. Keeping a rate hike on the table keeps the options for the Federal Reserve open.

Economic Projections
Economic Projections

Are the Fed’s “soft landing” hopes wrong?

Soft-Landing Hopes And Economic Realities

“On the eve of recessions in 1990, 2001, and 2007, many Wall Street economists proclaimed the U.S. was on the cusp of achieving a soft landing, in which interest-rate increases corralled inflation without causing a recession.” – Nick Timaros, WSJ

Similarly, the combination of easing inflation and a cooling labor market has fueled “soft landing” hopes among economists and Federal Reserve officials. However, soft landings are elusive as the Fed often holds rates too high for too long. Eventually, something breaks financially, economically, or both, leading to recessions and bear markets.

Fed Reserve and Financial Crisis
Fed Reserve and Financial Crisis

The Fed and most economists were wrong in 2022 when they forecasted an economic contraction. Economic growth, the labor market, and consumer spending proved unexpectedly resilient despite rising interest rates and elevated inflation. Much of that growth remains from the massive monetary liquidity still flowing through the economy.

M2 as % of GDP
M2 as % of GDP

With the restart of student loan payments, the UAW strike, and still high prices eating into consumer’s excess savings, that support is fading. However, other measures with near-perfect track records predicting recessions also suggest “soft landing” hopes are likely wrong.

Leading Indicators Lead

The Leading Economic Index is one of those indicators that should not be dismissed. As its name suggests, the data is forward-looking. With a negative reading for 17 months straight, the recession warning is quite evident. As shown, a recession occurred whenever the Fed hiked rates, and the 6-month rate of change in the LEI was negative by more than 2%.

Fed Funds Vs 6-Month LEI
Fed Funds Vs 6-Month LEI

However, our own Economic Output Composite Index, which comprises more than 100 data points of hard and soft, leading and lagging indicators, confirms the warning of the leading economic index.

EOCI vs 6-Month LEI ROC
EOCI vs 6-Month LEI ROC

Notably, since we know that increases in interest rates impact economic growth, it is unsurprising that when the annual rate of change in interest rates spikes, economic growth slows. Given the magnitude of the current rate of change in interest rates on a heavily indebted economy, the “soft landing” hope seems to be a stretch.

12-Mnth ROC of 10-Year Rates vs Economic-Composite
12-Mnth ROC of 10-Year Rates vs Economic-Composite

But one indicator suggests recession is most prominent in the second half of 2024.

The Risk Of Recession In 2024 Is Likely

Of all the economic indicators we regularly review, one has continually preceded economic recessions. While “soft landing” hopes are high, the inversion of multiple yield curves suggests those hopes are misplaced. As discussed previously, the media always assumes this time is different regarding yield curve inversions because a recession didn’t occur immediately upon the inversion. There are two problems with this way of thinking.

  1. The National Bureau Of Economic Research (NBER) is the official recession dating arbiter. They wait for data revisions by the Bureau of Economic Analysis (BEA) before announcing a recession’s official start. Therefore, the NBER is always 6-12 months late, dating the recession.
  2. It is not the inversion of the yield curve that denotes the recession. The inversion is the “warning sign,” whereas the un-inversion marks the start of the recession, which the NBER will recognize later.

If you wait for the official announcement by the NBER to confirm a recession, it will be too late. To wit:

“Each of those dots is the peak of the market PRIOR to the onset of a recession. In 9 of 10 instances, the S&P 500 peaked and turned lower prior to the recognition of a recession.

NBER Recession Dating vs S&P 500
NBER Recession Dating vs S&P 500

While many analysts will focus on one yield curve inversion, we monitor and track ten different yield spreads affecting various economic areas. Currently, 90% of the yield spreads we monitor, shown below, are inverted, which historically is one of the best leading recessionary indicators. However, even then, it was several months before the economy slipped into recession.

Which Yield Spread Matters
Which Yield Spread Matters

When these yield spreads turn negative, and a recession doesn’t occur immediately, the media discounts the risk. Such is why, before previous recessions, there were “soft landing” hopes. As shown, a recession followed an inversion of 50% or more of the tracked yield curves. Note that during the 1995 “soft landing,” yield curves never inverted.

Yield Curve Invesion Composite Index
Yield Curve Invesion Composite Index

Conclusion

Most importantly, it is NOT the inversion of the yield curves that denote the onset of a recession. It is when the yield curve UN-inverts that marks the start of the recession.

When the longer duration yields begin to fall, such will coincide with a decline in economic activity. Then, the “soft landing” hopes will fade into an economic recession reality.

The yield curve is sending a message that investors should not ignore. Furthermore, “risk-based” investors tend to act sooner rather than later. Of course, the contraction in liquidity causes the decline, eventually exacerbating the economic contraction.

Despite commentary to the contrary, the yield curve is a “leading indicator” of what is happening in the economy. However, the Fed remains focused on economic data that is “lagging” and subject to massive revisions.

While consumers may continue to support economic growth, such will change dramatically when job losses occur. As job losses increase, there is a rapid change in psychology.

Using the “yield curve” as a “market timing” tool is unwise. However, dismissing the message it is sending entirely is just as foolish.

History has not been kind to those that do.

Yield Curve Keeps Sending Message Investors Should Not Ignore
 

Related Articles

Yield Curve Keeps Sending Message Investors Should Not Ignore

Add a Comment

Comment Guidelines

We encourage you to use comments to engage with other users, share your perspective and ask questions of authors and each other. However, in order to maintain the high level of discourse we’ve all come to value and expect, please keep the following criteria in mind:  

  •            Enrich the conversation, don’t trash it.

  •           Stay focused and on track. Only post material that’s relevant to the topic being discussed. 

  •           Be respectful. Even negative opinions can be framed positively and diplomatically. Avoid profanity, slander or personal attacks directed at an author or another user. Racism, sexism and other forms of discrimination will not be tolerated.

  • Use standard writing style. Include punctuation and upper and lower cases. Comments that are written in all caps and contain excessive use of symbols will be removed.
  • NOTE: Spam and/or promotional messages and comments containing links will be removed. Phone numbers, email addresses, links to personal or business websites, Skype/Telegram/WhatsApp etc. addresses (including links to groups) will also be removed; self-promotional material or business-related solicitations or PR (ie, contact me for signals/advice etc.), and/or any other comment that contains personal contact specifcs or advertising will be removed as well. In addition, any of the above-mentioned violations may result in suspension of your account.
  • Doxxing. We do not allow any sharing of private or personal contact or other information about any individual or organization. This will result in immediate suspension of the commentor and his or her account.
  • Don’t monopolize the conversation. We appreciate passion and conviction, but we also strongly believe in giving everyone a chance to air their point of view. Therefore, in addition to civil interaction, we expect commenters to offer their opinions succinctly and thoughtfully, but not so repeatedly that others are annoyed or offended. If we receive complaints about individuals who take over a thread or forum, we reserve the right to ban them from the site, without recourse.
  • Only English comments will be allowed.
  • Any comment you publish, together with your investing.com profile, will be public on investing.com and may be indexed and available through third party search engines, such as Google.

Perpetrators of spam or abuse will be deleted from the site and prohibited from future registration at Investing.com’s discretion.

Write your thoughts here
 
Are you sure you want to delete this chart?
 
Post
Post also to:
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Thanks for your comment. Please note that all comments are pending until approved by our moderators. It may therefore take some time before it appears on our website.
Comments (12)
Ron Dwyer
Ron Dwyer Sep 29, 2023 3:18PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
so msm and the fed are fos .... totally agree. btw where is the climate change catastrophes that fat al and bratmouth have forecasted . maybe it's time for bidenomics as a forecast tool lol.
Mark Vanseventer
Mark Vanseventer Sep 29, 2023 3:18PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
Effects only just starting to clarify, but will probably be denied by some until its too late. Same people who will then be complaining nobody did nuttin’, most likely. Freedom of thought, though.
Orlin Penchev
Orlin Penchev Sep 29, 2023 3:18PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
in my youth, the winters were harsh and snow lasted for weeks. Today, at best, you will have it for the fb story and that's it. not to mention American style hurricanes which became more ans more common. true, not of the same magnitude, but 10-15 it was an exotic, and now - every year. So keep climate separate from your political and economic inclinea
uzah oui oui
uzah oui oui Sep 29, 2023 3:18PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
you should not breed ron, let your genes vanish for the good of the human race
dar dar
dar dar Sep 29, 2023 3:12PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
nonsense gas will be 250 a gallon in June of 24 38. mortgage rate will be 5.7. life will be good
Mitja Amon
Mitja Amon Sep 29, 2023 2:15PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
great article. nice analytical aproach!! sile-side analysts would never post simmilar article like this, so that whay are always wrong. or they have to be? :-)
Alan Je
Alan Je Sep 29, 2023 1:27PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
Good article.  M2 is an important component to watch for the economy's health, heart beat.  The Fed does usually wait too long to respond on interest rate moves, especially declines.  It's suppose to provide 'soft landings', but can be off.  Energy cost/supply is mostly the cause the current rate hikes.  May be, if not done, an analysis between interest rates and energy price, supply should be done.
Jimmy Doodoo
JimmyD Sep 29, 2023 1:02PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
So a recession in the 2nd half of 2024? Just in time for senile Joe's reelection defeat!
Otis Grant
Otis Grant Sep 29, 2023 12:55PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
The yield curve is artificially inflated from all the bond buying the fed did during covid. It's not a natural inversion, yet you bears can't get it through your heads. There is no recession in site, sorry. Look at employment and GDP or corporate profits for goodness sakes. Its not there
Jose Mibaresh
Jose Mibaresh Sep 29, 2023 12:33PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
You find it strange that your data indicates a recession should already be mostly over but one hasn't even started yet?
Otis Grant
Otis Grant Sep 29, 2023 12:33PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
Lol seriously
Nick Burns
Nick Burns Sep 29, 2023 12:10PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
So cuts March 2024 than? lol
Geovanna Roberts
Geovanna Roberts Sep 29, 2023 12:06PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
Great article!
Kool Aid
Kool Aid Sep 29, 2023 11:25AM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
I'm just gonna say it.  I love your articles.  They are not the easiest to get through, but dang there are some good insights in there.  Thank you!
 
Are you sure you want to delete this chart?
 
Post
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Add Chart to Comment
Confirm Block

Are you sure you want to block %USER_NAME%?

By doing so, you and %USER_NAME% will not be able to see any of each other's Investing.com's posts.

%USER_NAME% was successfully added to your Block List

Since you’ve just unblocked this person, you must wait 48 hours before renewing the block.

Report this comment

I feel that this comment is:

Comment flagged

Thank You!

Your report has been sent to our moderators for review
Continue with Google
or
Sign up with Email