The Atlanta Journal-Constitution
Why recession doesn’t seem imminent
Alarm bells sounded on Wall Street this week as something happened that hasn’t occurred in a decade: The U.S. yield curve inverted. This is one of the most reliable predictors of a recession, and it spooked investors enough to send the Dow down more than 700 points, along with the realization that a trade agreement with China may be more difficult to achieve than first expected. But this doesn’t mean a recession is happening tomorrow or even in 2019.
What happened Monday?
The yield (amount of interest) on the two- and three-year U.S. Treasury bonds moved above the yield on the five-year Treasury bond. Inversion is when a short-duration bond is suddenly worth more than a long one.
“A flattening yield curve traditionally has been seen as a sign that investors expect future growth to weaken,” Vincent Heaney, Jon Gordon and Chris Swann of UBS wrote in a client note. “An inverted yield curve is seen by some as an early warning sign of an impending recession.”
Does this tell us anything about the timing of a possible recession?
As UBS noted, this is an early warning sign, and it could take years for the recession to materialize. Consider what happened leading up to the Great Recession: The three-year bond yield moved above the five-year in August 2005, more than two years before the recession began in December 2007. The more closely watched indicator is when the two-year bond yield moves above the 10-year bond yield, something that hasn’t happened yet.
According to many Wall Street analysts, this week’s inverted yield curve isn’t a reason to panic but is another sign that the U.S. economy is probably peaking. Growth is widely expected to slow somewhat next year and even more so in 2020.
Are consumers getting nervous?
How much and how quickly the economy tapers is going to depend on U.S. consumers. Roughly 70 percent of the U.S. economy is powered by consumer spending. As long as consumers are happy and opening their wallets, the economy will keep growing, and right now, consumers are in very good shape.
“This is the most confident American consumers have been in 18 years,” said Lynn Franco, director of the team that produces the Conference Board’s Consumer Confidence Index. “Just on holiday gifts, consumers plan to spend around $627 this year versus $560 last year, one of the strongest jumps we’ve seen.”
What’s helped keep consumers optimistic?
U.S. household incomes are rising as more people find jobs, and wage growth is at the highest nominal level in nearly a decade. More than 2.7 million more Americans are employed now vs. a year ago, the biggest gain since 2014. In many communities, people see visible signs of the economy’s strength when they view so many “We’re hiring!” signs around town. Franco says good job prospects are a key driver of consumer sentiment.
Consumer sentiment has remained strong all year despite political head winds and market jitters. People appear to be focusing on their own improving financial situations and not the headlines.
“Consumers have been pretty accurate forecasters of a recession,” Franco said. “There is usually a sharp decline in expectations for the future, followed by a decline in how consumers view the present situation.” But she said she’s not seeing that now.
Are there other factors?
On top of job and wage gains, many Americans have more money in their pockets from tax cuts. The typical middle-class household, earning $49,000 to $86,000 a year, received a $900 tax cut this year, according to the nonpartisan Tax Policy Center.
Earlier this year, there were concerns that higher gas prices were eating up a substantial chunk of the tax savings as families had to shell out more money at the pump, but gas prices have fallen sharply in recent weeks and are now at a lower level than they were a year ago, according to the U.S. Energy Information Administration. It’s another factor helping consumers feel better off and making them likely to spend more.
“The recent drop in retail gasoline prices is poised to lift disposable income in the coming months,” said Neil Dutta, head of Renaissance Macro Research. “Disposable income is the main driver of consumption.”
What about any warning signs?
If there’s a head wind for consumers, it’s debt. Household debt — mortgages, student loans, auto loans, home-equity lines of credit and credit cards — has now topped $13.51 trillion, which is above the previous peak from 2008, just before the worst of the financial crisis hit. Student loans often get the most focus since nearly 1 in 5 adults have some sort of student debt. Experts say it’s a clear hindrance, but they are encouraged that credit card and mortgage debt remain in check this cycle.
“People are using credit in a prudent way. They aren’t loading up on their credit cards,” said Jack Kleinhenz, chief economist at the National Retail Federation. He pointed out that household debt as a percent of household income is low by historical standards.
What should we keep an eye on?
An early warning sign could be car loans. Auto loans that are 90 days delinquent just hit the highest level since early 2012, according to New York Federal Reserve data. Auto loan delinquencies have steadily risen in the past six years, even as the economy has improved. It is a likely indication that lower-income Americans are still struggling, even though many states and the nation’s two largest employers — Walmart and Amazon.com — have lifted their minimum wages.
But Dutta of Renaissance Macro Research pointed out that disposable income has been rising 3.1 percent in the past five years while consumption has risen 3 percent, meaning a lot of people are living within their means. Dutta said that is a “dramatic departure” from the late 1990s and early 2000s, when consumption outpaced income by a sizable amount.
This week’s inverted yield curve is a reminder that the economic head winds at home and abroad are picking up. But experts say to watch the consumer for the best gauge on the U.S. economy’s health. So far, most signs point to ongoing strength.