by D.J. McGuire
On 22 March 2019, an event occurred that signaled the Trump Administration may not make it past January 2021.
For this was the day Special Counsel Robert Mueller delivered his reportThis post is not about any of that.
Early that morning, the bond markets witnessed an event not seen in twelve years, months before the Great Recession that some say it predicted – the inversion of the yield curve (Bloomberg).
The Treasury yield curve inverted for the first time since the last crisis Friday, triggering the first reliable market signal of an impending recession and rate-cutting cycle.
The gap between the three-month and 10-year yields vanished as a surge of buying pushed the latter to a 14-month low of 2.416 percent. Inversion is considered a reliable harbinger of recession in the U.S., within roughly the next 18 months.
In theory, and almost always in practice, the interest rate on a three-month bond (i.e., loaning money to the government for three months) is lower than the 10-year bond (loaning it to the government for a decade). The longer someone is locking away their money in an asset like a bond, the higher interest rate they would normally want.
The nuts and bolts go like this: bond interest payments are constant – in dollars. The bond interest rate is thus dependent on the bond price. If, say, a bond paying $50 a year in interest sells for $1000, the interest rate is 5 percent. If the interest rate (a.k.a., the yield) falls to 4 percent, it means the price of the bond has risen to $1250. So when, instead, investors are ready to accept lowerinterest rates for longer loans to the feds, it means they’re paying higher prices for the longer bonds than for the shorter ones.
Why would longer bonds, with less relatively liquidity, be in higher demand than short-term bonds? Because investors don’t have a lot of confidence in the short-term health of the American economy.
The last time this happened was in early 2007. The Great Recession started less than a year later.
Lest anyone think this is a recent correlation (USA Today, emphasis added) …
This warning signal has a fairly accurate track record. A rule of thumb is that when the 10-month Treasury yield falls below the three-month yield, a recession may hit in about a year. Such an inversion has preceded each of the last seven recessions, according to the Federal Reserve Bank of Cleveland.
Now, predicting the future is a mug’s game (especially for yours truly). Indeed, Michael Darda told CNNthat one day of inversion may not mean much.
Michael Darda, chief economist and market strategist at MKM Partners, said in a note that investors should wait for weekly and monthly averages to show an inversion before they read it as a “powerful recession signal.”
But here’s where Trump could be in serious trouble, according to Darda: “He noted that on average, recessions occur 12 months after an inversion — not immediately.”
In other words, if this inversion is signaling a recession, it could come smack in the middle of Trump’s re-election campaign.
The last time an incumbent president won an election with a recession in an election year was Harry Truman in 1948 – and as that recession began in November, it may not have begun until after the votes were cast.
If you’re looking for the last incumbent to win while a recession inarguably happened during the campaign, you have to go back to Calvin Coolidge – in 1924 (data: National Bureau of Economic Research– the folks who make the official declaration on when recessions begin and when they end).
There are arguments about how much credit Trump deserves for an economic recovery that began more than seven years before he took office. There are arguments about how his tax policies (including tax increases on imports) have affected the economy. However, a recession in 2019 or in 2020 would be one that he owns – and history shows voters do not re-elect presidents campaigning during recessions.
If a recession is indeed coming, it could be what keeps the president from winning a second term – and the first sign of it came with Friday’s yield inversion.