Troubling Economic Signals Ahead of Jackson Hole Meeting

The financial media seized upon news of the yield curve inverting last week as a possible harbinger of a recession in the United States, which could in turn trigger a global economic slowdown. The curious bond market phenomenon is one of several signs of economic fragility that loom ahead of the Fed’s Jackson Hole meeting starting this Friday.

Inverted Yield Curve

The yield on the benchmark 10-year US Treasury note fell below the 2-year rate last Wednesday morning, causing an inverted yield curve. This means that investors were willing to receive less yield on 10-year bonds than on 2-year bonds, despite locking up their capital for a longer period. Investors would only do this if they believe that yield on the longer term bond will fall even more, suggesting a negative expectation for the stock market and economy.

The Dow Jones Industrial Average shed 800 points, or 3% for the day on the heels of the news. The inversion has not happened since December 2005, two years before the recession caused by the financial crisis of 2008.

This unusual bond market signal suggests that investors are preparing for a slowdown in both the US and global economies. However, some analysts downplayed the alarmist headlines, pointing out that the yield curve may be distorted by factors such as negative interest rates in Europe and the codependence between the markets and the Federal Reserve. Also, the inversion was very brief so far, reverting by the end of the week.

Finally, there is typically a substantial lag between the inversion of the yield curve and the onset of a recession. According to research from Credit Suisse, a recession occurs on average 22 months following such an inversion.

Trade War and Contracting Economies

Fears are increasing that the US/China trade war may be leading the global economy to a recession. China’s economy is growing at the slowest rate in 30 years. Data from the Chinese government showed that the economy grew by 6.2% in the second quarter of 2019, falling from 6.4% in the first quarter.

Growth in Europe is also softening and the German economy contracted in the second quarter. Last week, data showed that Europe’s biggest economy and export powerhouse contracted 0.1% in the second quarter, marking the end of a ‘golden decade’. German industrial production suffered its largest annual decline in nine years, falling 1.5% in June and expected to drop by another 1.5% in July due to declining orders from China.

The economy of the United Kingdom also shrank in the second quarter, the first contraction since 2012 amid persisting Brexit woes.

Gold and Copper

Another canary in the global economic mine is to look at the relationship between gold and copper prices. When investors foresee economic slowdown they tend to sell copper and buy gold. Copper is often viewed as an indicator of industrial health. Rising copper prices suggest strong copper demand and healthy economic growth, while declining copper prices suggest possible weakness ahead. Copper prices have been trending lower and are close to multi-year lows. Meanwhile, gold is considered a safe-haven and an attractive store of value during economic recession. Gold prices have soared in 2019, recently reaching six-year highs.

The Bottom Line

At the Jackson Hole meeting Federal Reserve Chairman Jerome Powell will speak for the first time since the yield curve inverted. Last week, data showed that US retail sales rose by the most in four months in July, indicating that consumer spending remains robust. However, a quarter-point interest rate cut is fully priced in for September and investors will be looking for clues for whether a half-percentage-point cut is in the cards.