Surefire Recession Signal in Pictures

The strength of inversions widened today. That's a strong recession warning, but it is not the actual recession signal.

Inversions Widen

Today's bond market action is a strong follow-through on Friday's action.

Imminent Signal

The recession imminent signal is not the inversion but a sudden steepening of the curve following a period of inversion.

A comparison of the strength of the inversions today vs 2007 will show what I mean.

Inversions With the 3-Month Note Today

The 10-year, 7-year, 5-year, 3-year, and 1-year notes are inverted with the 3-month T-Bill. The inversion isn't the signal. A sudden steepening of the yield curve following inversion is the "recession imminent" signal.

Inversions With the 3-Month Note 2007

Chart 1 Repeated for Ease in Reading

Signal Discussion

  • Box 1, Box 4, and Box 5 all have the same thing in common: A sudden steepening of the 3-Month to 10-Year and 2-year to 10-Year curve following inversion.
  • Box 2 had no inversions
  • Box 2 and Box 3 show a steepening of the 3-month to 10-year spread but not the 2-year to 10-year spread.

Some are waiting for a 2-10 inversion. Perhaps it does not happen. But even if it does, that will not be the signal.

Watch for a sudden steepening of the curve following an inversion.

How? Why?

That's easy. The Fed will either cut or signal it is about to cut.

Too Late

On August 17, the Fed Cut the Discount Rate by 50 Basis Points

Fed Statement: Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.

Flashback September 18, 2007

Inquiring minds are investigating the Minutes of the August 7, 2007 FOMC meeting released September 18, 2007.

Amazingly Wrong Points

  • At its August meeting, the FOMC decided to maintain its target for the federal funds rate at 5-1/4 percent. In the statement, the Committee acknowledged that financial markets had been volatile in recent weeks, credit conditions had become tighter for some households and businesses, and the housing correction was ongoing. The Committee reiterated its view that the economy seemed likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.
  • Conditions in corporate credit markets were mixed. Investment- and speculative-grade corporate bond spreads edged up; they were near their highest levels in four years, although they remained far below the peaks seen in mid-2002
  • In preparation for this meeting, the staff continued to estimate that real GDP increased at a moderate rate in the third quarter. However, the staff marked down the fourth-quarter forecast, reflecting a judgment that the recent financial turbulence would impose restraint on economic activity in coming months, particularly in the housing sector. The staff also trimmed its forecast of real GDP growth in 2008 and anticipated a modest increase in unemployment.
  • With credit markets expected to largely recover over coming quarters, growth of real GDP was projected to firm in 2009 to a pace a bit above the rate of growth of its potential.
  • Participants thought that the most likely prospect was for consumer expenditures to continue to expand at a moderate pace on average over coming quarters, supported by growth in employment and income.
  • In the Committee's discussion of policy for the intermeeting period, all members favored an easing of the stance of monetary policy. The Committee agreed that the statement to be released after the meeting should indicate that the outlook for economic growth had shifted appreciably since the Committee's last regular meeting but that the 50 basis point easing in policy should help to promote moderate growth over time.

Yield Curve Reaction

The Fed did not reduce the Fed's fund rate. So, why did the yield curve react?

The Fed did slash the discount rate by 50 basis points. The yield curve reacted sharply.

If you think the Fed has a handle on stopping the next recession think again.

As in 2007, they will not even see it. Nor would they admit it if they did.

Watch for Steepening

Watch for a sudden steeping of spreads. Don't expect a long warning period, and don't pay attention to the Fed or president Trump yapping about the strong economy when it happens.

I expect the delay this time may be negative, the recession will already have started.

Miracles Not Coming

The Fed blew another magnificent bubble.

Don't expect miracles. The next recession is baked in the cake.

Correction: I inadvertently switched comments for box 2 and box 3, now fixed.

Mike "Mish" Shedlock

Comments (38)
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Blurtman
Blurtman

Irrefutable science.

DFWRealEstate
DFWRealEstate

QE to infinity and beyond...or bust. No surprise that we arrived here in this situation. It was folly from the beginning to think we could pour all of that liquidity into a corrupt financial system and produce a sustainable recovery.

Matt3
Matt3

I'm sure there will be a recession at some point and when we look back it will be obvious from some indicator. Not sure what steps I would take if I knew it was coming in 3 -6 months. Kind of looks like there is no place to hide.

LawrenceBird
LawrenceBird

So basically what Mish and others are saying is that the US economy is unable to prosper/grow with a real rate of interest over 0%. How sad is that? I'm sad that the Fed did not have the ****s to hike up to 4% and put the unicorns and zombies under once and for all. No pain, no gain but at least Granny will have some interest money to buy cat food.

Bam_Man
Bam_Man

"It will be a big, beautiful recession. Very big and beautiful."

Liberaldisdain
Liberaldisdain

The broken clock is back. yay! Maybe you will finally be right. Better 10 years late than never!

Carl_R
Carl_R

To appreciate the task of the Fed, consider driving a car down the highway. It's not a difficult task, because when you look out, you can see where you are, and where you are going, and when you turn the steering wheel, something happens immediately and the direction changes.

Now lets say that you can no longer look out. Instead, to determine your current position, you are given some vague statistics that sort of tell you where you are...or, perhaps, where you might be, and sort of which direction you might be going. Next, let's add some delay in the steering mechanism, so that when you turn the wheel, nothing happens right away, but some months later, your course has been slightly altered, in one direction or the other.

Could you keep on the road that way? I know I couldn't, and I doubt anyone could. That's why Milton Friedman used to argue that it was futile to even try. Instead, he argued, the Fed should be content to focus on an orderly expansion of the money supply, and quit trying to do the impossible, micro-manage the economy.

jivefive99
jivefive99

"Box 2 and Box 3 show a steepening of the 2-year to 10-year spread but not the 3-month to 10-year spread." I think this is switched. The blue lines did steeply rise for box 2 and 3 and the blue lines are the 3-month to 10-year. ???????

Mish
Mish

Editor

""Box 2 and Box 3 show a steepening of the 2-year to 10-year spread but not the 3-month to 10-year spread." I think this is switched."

Good catch I inadvertently switched my comments

Mish
Mish

Editor

Correction: I inadvertently switched comments for box 2 and box 3, now fixed.

Casual_Observer
Casual_Observer

After a decade of low rates all we has was a weak economy , a crack hit from a tax cut and now we go back to a weak economy. Problem is corporate bond resets are baked in. Rate cuts are coming but wont save anything. The federal budget is going to get crushed.