Today’s yield on the 10-year treasury dropped to 2.96%, putting it within one basis point of the 1-year Treasury at 2.87%, nearly inverting, suggesting recession ahead, prompting a major sell off on Wall Street dropping the Dow Jones Industrial 791 points to 25,034 or 3.06%. Fairing even worse, the tech-rich Nasdaq Composite dropped 283 points to 7,158 or 3.80%, giving back the pre-Christmas rally started last week when 65-year-old Federal Reserve Board Chairman Jerome Powell signaled that he was nearing the bottom of Federal Funds rate hikes. Since taking over from former Fed Chairman Janet Yellen, Feb. 5, Powell raised the Federal Funds Rate three times to its current rate of 2.25%, not high by historic standards but the highest point since former Fed Chairman Ben Bernanke dropped the Federal Funds Rate to zero-to-quarter percent Dec. 18, 2008 to stave off anther Great Depression.
Since taking office, Powell misread inflation metrics suggesting that the improving Gross Domestic Product [GDP] would allow the Fed to start hiking rates. Economists like Yale University Robert Shiller and Wharton School economist Jeremy Siegal cautioned Powell on hiking rates too frequently, believing U.S. economic growth was still fragile. Allianz SE chief economist Mohammed El-Erian, parent company of PIMCO, the nation’s biggest bond fund, urged Powell to take a more cautious approach to rate hikes. Powell ignored calls for caution given the slowing economies in China, India and Europe. Today’s whopping drop on the Dow, Nasdaq and S&P 500 indicates that Wall Street sees slow growth, if not recession, in 2019. While everyone wants a Christmas rally, the nation’s biggest funds have taken a defensive strategy. No longer just cyclical profit-taking, Wall Street has eyes recession.
Lurking beneath the surface in 2019 are exploding federal budget deficits, now over $888 billion, increasing 33% since Trump took office. Passing sweeping tax and regulatory reform Dec. 22, 2017, it was just a matter of time before Trump’s fiscal policy came back to bite him. Since the days of Ronald Reagan, the GOP always hoped that tax cuts would stimulate the economy, boosting government revenues by lowering the unemployment rate. Like it was in the 1980s, tax cuts produced whopping federal budget deficits, the same thing that’s happening now. Economist aren’t worried about today’s $888 billion deficit, they’re concerned about the deficit going through the roof in 2019, well above $1 trillion. Flattening or inverting of the yield curve has predicted slow growth and recessions since WW II. With Powell not caught up with reality, economic growth looks problematic in 2019.
All nine of the recessions since 1955 have been preceded by a flattening or inversion of the yield curve, especially between the 2-year and 10-year-treasury bonds. Market corrections or cyclical profit taking don’t come with flattening or inverted yield curves, suggesting that today’s sell-off hints at slower growth, if not recession, in 2019. Calling the inversion in the yield curve “potentially the first shoe to drop in the rate cycle,” Bloomberg’s macro strategist Cameron Crise, cautioned about slower growth. Slow growth doesn’t bode well for corporate earnings, something that drives markets averages up or down. “Mind you, there can be a long delay between the first inversion of the curve and subsequent rate cuts, as the last cycle showed,” Crise said, sending a strong message to Powell.
Powell’s gung-ho tightening schedule showed that he was prepared to fight inflation by plunging the economy into recession. Under his predecessors Bernanke and Yellen, the economy functioned well in the low interest rate environment, despite not giving the nation’s biggest banks anything to cheer about. With higher interest rates, bank profits indeed climbed in 2018 but at the expense of the overall economy. Without proof that the economy was going gangbusters, Powell should have been more cautions hiking rates since taking over from Yellen in February. Powell showed that monetary policy is a powerful tool to control inflation, but, more importantly, the nation’s GDP. President Donald Trump said Oct. 19 that Powell had “gone crazy” with rate hikes, saying he would kill everything he’s worked for. Trump got criticized in the press for meddling with the Fed’s monetary policy.
When Powell signaled Nov 28 that the Fed’s monetary policy was “near neutral,” meaning that, for the time being, rates had gone up enough, markets rallied. Powell’s admission suggests that he went too-far-too-soon with rate hikes, throwing the brakes on the nation’s GPP. “One of the most pervasive relationships in macroeconomics is that between the term spread—the difference between long-term and short-term interest rates—and future economy activity,” said San Francisco Fed’s Michael D. Bauer and Thomas M. Mertens back in March. Yet when you look at Powell marching ahead with rate hikes, it shows that the Fed’s left hand doesn’t know what its right hand is doing under Powell’s leadership. All the inflation hawks haven’t understood the fragile nature of the U.S.—and world—economies since the global financial crisis and Great Recession of 2008. Powell must pivot quickly or consider retirement.
