There are already many signs pointing to a recession ahead. We are, after all, in the Everything Bubble.
The last piece of confirmation I have been looking for just came. The 3-month yield is now higher than the 10-year yield. The mostly inverted yield curve points to a major recession in 2023.
Some people look at the 2-year vs. 10-year yields for inversion. These have been inverted for several months. The 2-year has frequently been 40 basis points or more higher than the 10-year yield.
I prefer to see an inversion of the 3-month yield and the 10-year yield for recession confirmation. Of course, nothing is guaranteed. We should have seen a deep recession in 2020 after the curve inverted in 2019. But we got COVID hysteria and trillions of dollars of fresh money from the Fed, which delayed and exacerbated the inevitable.
Now we have high consumer price inflation, even according to the government’s own statistics. The Fed can’t just create trillions of dollars more in new money to fight the next recession; otherwise they risk losing control of the dollar. The Fed may be made up of a bunch of Keynesians, but they don’t want hyperinflation.
So the yield curve is now inverted while the Fed continues to hike its target interest rate and slowly draining its balance sheet. If you think stocks have fallen hard in 2022 so far, hold on to your hat. Things may have just gotten started. The same goes for housing in most areas.
The Numbers
The 3-month yield closed above the 10-year yield on October 18, 2022 by 3 basis points (.03%). The 10-year yield jumped the next day, and it was no longer inverted.
On October 25, the 10-year yield started to go back down, while the 3-month yield continued higher. In just 3 days, the 10-year yield has dropped almost 30 basis points from 4.25% to 3.96%. The 3-month yield now sits at 4.13%.
In fact, as of this writing, the yield on a 30-year bond is actually slightly lower than on a 3-month Treasury bill. Who in their right mind would accept a lower interest rate for 30 years as compared to 3 months?
The answer is somebody who expects long-term rates to fall due to a really bad recession.
The bond market is typically thought of as the smart market. The stock market doesn’t have this reputation unless you talk to a bullish stock investor.
Of course, markets themselves are neither smart nor stupid. But the mania investors go into stocks. Bond investors are not just trying to make a quick buck. They are often just trying to preserve capital.
The bond market tends to be a better predictor of the future economy. And there is no clearer sign that a recession is on the horizon than an inverted yield curve.
More Confirmation
I already thought a recession was coming. The speculative mania in stocks, real estate, crypto, and nearly everything else has been extraordinary up until this year. It all came on the heels of the Fed’s easy money policies.
With consumer price inflation nearing double digits, the limits seem to have been reached. The major inversion of the 2-year and 10-year yields was already pointing to trouble ahead. I wasn’t sure if we would see an inversion of the 3-month and the 10-year. It took some time, and here we are.
And the Fed isn’t done raising rates. There is another meeting next week where we will see another major hike to fight the inflation that the Fed itself created.
I’m not sure that people are quite prepared for what we are about to see. Government spending is already through the roof. While a major recession should point to lower interest rates (as investors seek safety in U.S. Treasury securities), who is going to buy this debt at low interest rates in the long run if not the Fed?
The Fed is actually slowly selling off debt at this point. What will happen to the trillion-dollar deficits? If interest rates continue to go up, the burden of the interest payments on the debt will become quite significant.
If we are facing a major recession and a popping of the Everything Bubble, what happens if price inflation doesn’t come down to the Fed’s 2% number? Imagine if the Fed is still raising its target rate in the middle of a brutal recession. The last time anything like this was seen in the United States was in the 1970s and very early 1980s.
There are warning signs everywhere that things are going to get bad. The inverted yield curve with the Fed continuing to tighten monetary policy by itself is enough to know just how ugly things could get.
Stocks will not go straight down. In fact, if you like to day trade, it will be a dream for people who know what they are doing. There will be many up days too. There will be a lot of volatility. But there will be more and bigger down days than up days.
As someone who follows the Austrian school of economics, I am hesitant to make predictions about the future. We can’t predict human action with certainty.
In this case, I think it is a near certainty that there will be a recession in 2023, and it is going to get ugly. The best hope is that the Fed allows it to happen and the government is forced to scale back its spending. The system needs to be cleansed of the malinvestment that has occurred, particularly since 2008.