For a while there it looked like the US and its main trading partners had
finally achieved escape velocity. Growth was up, inflation was poking through
the Fed's 2% target, and most measures of consumer
sentiment were bordering on euphoric.
Then it all started to evaporate. Lackluster manufacturing and consumer
spending reports sent the Atlanta
Fed's reading of Q1 GDP off a cliff to less than 1%:
And this morning the Wall Street Journal highlighted some recent changes
in the yield curve that point towards further slowing:
Flatter
Yield Curve in 2017 Shows Growth Concern Lingers
Long-term Treasury yields have declined modestly, while short-term yields
have risen.
A flattening of the Treasury yield curve in 2017 is a worrying sign for
investors banking on resurgent U.S. inflation and growth.
Long-term Treasury yields, which are largely driven by the U.S. economic
and inflation outlook, have declined modestly this year, following a sharp
rise in the wake of the November election of Donald Trump as president. The
10-year U.S. Treasury yield has fallen to 2.396% from 2.446% at the end of
2016.
At the same time, short-term yields, which are more influenced by monetary
policy, have risen in 2017 as Federal Reserve officials have made clear that
they expect to continue raising the fed-funds rate through the rest of the
year.
As a result, the yield premium on the 10-year note relative to the
two-year note—known in the market as the 2-10 spread—slipped Wednesday to
1.107 percentage points, its lowest level since the election.
FIRST QUARTER REPORT CARD
While the yield curve, like all market indicators, is subject to the ebb and
flow of investor sentiment, economic data and political developments, a
flattening yield curve gets special attention from investors world-wide
because it can serve as an early signal of both economic slowing and
overpricing in riskier asset classes.
Those concerned that U.S. share prices were getting ahead of themselves
took note in the first quarter when they "started to see the flattening
of the yield curve," said David Albrycht, president and CIO of Newfleet
Asset Management, the fixed-income affiliate of Virtus Investment Partners .
The Dow industrials have fallen 2% since hitting a record of 21115 on March
1.
Though economic data in the first quarter were mixed, many investors
believe the flattening of the curve is the result of the unwinding of
"Trump trade" bets that inflation and growth would pick up
imminently with the adoption of tax cuts and fiscal stimulus President Donald
Trump has promised. Hopes of a so-called reflationary agenda have been set
back by the defeat in Congress of a White House sponsored health-care bill.
That raised questions about whether Mr. Trump can get other legislation
through Congress.
Expectations for higher long-term yields and a steeper curve rested on two
pillars: first, that the economy on its own was showing signs of improvement,
and second, that it would get an extra lift from promised tax cuts,
infrastructure spending and regulatory relief.
At the outset of the second quarter, both of those pillars are still
standing, yet neither is looking as sturdy as before.
The Journal goes on to note that the spreads between Treasuries and junk
bonds are widening, which indicates growing fears of a slowdown-induced
credit crunch. And that junk bond issuance is soaring, which implies a desire
on the part of sub-investment-grade borrowers to raise cash while they can.
What's happening? There are several possibilities:
1) There never really was a recovery. The post-election pop was, as the
Journal asserts, just the human nervous system responding to a "new and
improved" US government the way grocery store shoppers instinctively
reach for boxes that promise a better version of an old stand-by. Now that
the novelty has worn off, the markets are experiencing a "same corn flakes,
different box" let-down. In which case 1% - 2% growth might be the
ceiling, and debt/GDP will continue to soar world-wide. Make no mistake, this
is an epic worst-case scenario.
2) Oil spiked in 2016, which led many to conclude that the global economy was
growing because it was demanding more energy. But then crude gave back most
of its gains, extinguishing the previous optimism and causing economic
indicators like consumer spending to stall (because we're all paying a bit
less for gas lately). So risk-off: sell stocks and junk bonds, buy
Treasuries. It's no more complicated than that.
3) No one has the slightest idea what's happening as insane levels of debt
distort the models economists use to predict the future. From here on out,
it's unpleasant surprises all the way down.
Time will tell, but door number 3 is an increasingly safe bet.
