It is true that the world’s prime economic power has grown for 114 consecutive months. And, according to the National Bureau of Economic Research (NBER), it is within 6 months of breaking the record for the longest expansion which began in 1991 and ended exactly 10 years later. But, if the stock market predicts recessions, we are not doing well.
Wall Street has spent the whole year in a saw teeth configuration. Although it has marked historic highs (in January and September), the year which is ending has been characterised by lurches in the market, which have resulted in the difference between highs and lows in the S&P 500 reaching 11%. In fact, in the 10 weeks between the end of September and the beginning of December, the S&P fell 10%. Worse were the two weeks between January and February, when the same fall was produced in only two weeks. In other words, in the eleven first months of this year Wall Street has had two historic highs and two corrections. And at a little over two weeks before the end of the year, all of this has been reflected in a stock market that is 2.3% lower than on 2 January.
But, as if stock market uncertainty was not enough, now fixed incomes have joined the chorus of anxiety. Since the summer, the yield curve has been flattening, in what appears to be the clearest sign of a recession in sight. And in December it inverted. In other words, long term debt began delivering poorer returns than short term debt. Or at least, this is what the Cassandras of the market were selling, who at this moment are much grown. However, the differences between these types of assets are not indicators of a recession.
The possibility of a recession is a function of the difference between the short and long term returns of Treasury bonds. And five year bonds are not considered long term. The key is in the difference between 2 and 10 year debt. This difference remains positive … but by the minimum. On 7 December it narrowed to 12 base points, the lowest since 2007, when the US was already mired in the subprime mortgage recession. This suggests we are not at the gates of a recession. But we are in serious danger of falling into one.
A scarcely more reliable measure than the difference between 2 year and 10 year bonds is that used by the Cleveland Federal Reserve, which measures the difference between 3 and 10 year bonds to then construct a model which evaluates the possibility of a recession. According to this indicator, the US has a 20% chance of falling into an economic contraction in 2019. At first sight, it doesn´t seem much. But if you put the figure in historical perspective, matters changes. The chances of a recession have not been as high since 2007.
But there is another way of evaluating the difference: at face value. In other words, for what it is, and no more. That the return on two year debt is greater than on five year dent implies, simply, that the market believes the Federal Reserve is not going to increase interest rates from now until the next two or fives years. With the interest rise in December discounted, which the market unanimously expects, this suggests that interest rates have already reached, virtually, their equilibrium level.
This a perception held by many operators. And it is based on a speech which Fed President Jay Powell gave in the New York Economics Club on 28 November, in which he announced that the interest rate is just below its natural level (that is to say, that which neither slows nor accelerates the economy). If that is the case, effectively, the Fed is about to stop hitting the accelerator on interest rates. But this means that he does not want to see the loss of the central bank´s policy independence with Donald Trump.
Between 3 October and 28 November, Powell received a stream of tweets and declarations from the US president pressuring him. Trump seems to have confused the US central bank with Deutsche Bank, one of the few major banks which still lent him money, given that American banks stopped lending to him in the 90s, when they realised that he had a tendency of not repaying his debts.
The interference of Trump in the Fed is normal with a politician who doesn´t understand the difference between the state, government, party and himself. But it points indirectly to a threat to the economy in 2019 which is beginning to weigh on investors: institutional instability and geopolitical risk. General Motors and Ford have declared that the tariffs on steel have cost them in the second half of the year 1 billion dollars each. The losses for the agricultural sector in the Mid-West are also measured in billions of dollars.
To this are added the permanent geopolitical risk from the Russian issue, the scandals of Trump with the porn actresses Stormy Daniels and Karen Mc Dougal, and the legal processes against the president for conflict of interest.
So far, the markets have been able to leave these questions to one side because Trump´s tax cuts have raised the margins of companies in the stock market and launched a tsunami of dividends and transactions in treasury stock. But, with the impact of tax cuts, which tool place on 1 January, is already weakening, the lack of a real economic policy in the US is beginning to matter.