when the bond market disconnects from everything else, we should pay attention
As I wrote about before, earlier this month the US yield curve inverted, which means overnight interest rates are higher than long-term interest rates, for the first time since the pandemic recession. The strongest indicator of an upcoming recession that we have is an inverted yield curve. There is one stronger indicator that a recession has already arrived -- quickly increasing unemployment -- but by then it is too late, the recession has already arrived. If you're looking for a consistent predictor of an upcoming recession, an inverted yield curve is the best we've got. After 8-10 months of inversion, a recession is definitely coming.
Then after unemployment has increased by at least half a percentage point within three months (quarter-over-quarter), the recession has already arrived.
But we're only within Month One of the current inversion. Perhaps the inversion won't last the minimum length of time required to cause a recession. We've got about nine months left for interest rates to return to a normal upward-sloping curve. The Fed hasn't always waited 8-10 months before retreating.
As I wrote before, I can't predict what a group of humans will decide in the future. But there is a futures market where investors place bets with real money on future interest rates. The futures market predicts the yield curve will remain inverted through September 2024, which would be for 22 months. This would be the longest yield curve inversion in recorded history. So, the bond market is definitely expecting the Fed to keep shooting until a recession has begun.
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But then I read people's opinions about politics, because I'm a political news junkie as well as an econ stats junkie, and I see an incredible disconnect. Nobody in the political world seems to be expecting a recession between now and November 2024. As people handicap Trump vs. other Republican candidates, and people wonder whether Biden will be too old ... nobody seems to get that we'll be in an old-fashioned classical business-cycle recession by then with skyrocketing unemployment and bankruptcies. And unlike the pandemic recession, we won't be able to blame COVID, we won't be able to blame state governors for not reopening their economies or schools or whatever.
And therefore, Democrats will lose the White House, no matter who Democrats nominate, no matter who Republicans nominate. There is no example of a President surviving a recession since at least before the Great Depression.
The actions of the Federal Reserve over the next year are far more important to our political future than the endless nomination processes of the two major parties.
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And then there's the stock market. As measured by the S&P 500, it peaked on January 3rd of this year and is down 17% so far. Not a good year for stocks as interest rates have quickly increased. But compared to earnings, stock prices are still about twice as high as they were during the last business-cycle recession (2009), and about four times as high as they were the last time the Fed was battling inflation of 8% (1982).
Anybody paying attention to the bond market and economic history should understand how risky stocks are right now. It would be consistent with both current conditions and economic history for the stock market to fall by 50-75% over the next few years. Yet I see very few people worried about such a tumble, even though cryptocurrencies are down 75% from a year ago. If it can happen to crypto, why can't it happen to stocks?
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When my Lyft drivers are giving me stock-picking advice, when the porn stars I follow on Twitter are giving me stock-picking advice ... this is anecdotal evidence of course, but it is still indicative that we're in bubble times. The amazing thing to me of the past 25 years is how we keep on blowing new financial bubbles even after we've witnessed them crashing. Why didn't we learn from the stock market bubble of the late 1990s? Why didn't we learn from the real estate bubble of the late 2000s? Why haven't we learned from the crypto bubble of the early 2020s?
When investors gauge the "value" of an investment by how much it is going up, that's a bubble mentality. The US has been living inside a bubble mentality for 25 years now, and every time a bubble pops we expect the Federal Reserve and the US Treasury to bail us out. And then we experienced a real-life pandemic, the worst in a hundred years, and we reacted by having the Federal Reserve and the US Treasury bail us out, and we bubbled on.
Maybe it's another feature of the Internet, this Age of Serial Bubbles. As the Internet has disintermediated all sorts of prior relationships, it has also put financial bubble participation apps into the hands of each person. You too can buy crypto at the touch of a finger. You too can day trade in ETFs. People used to ask the advice of professional stock brokers, now they trade memes on Reddit and Twitter. Fortunes can be made if you ride the memes upward, but plenty of people have also lost their life savings by betting them on pure fantasy.
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But now we've finally re-entered the world of inflation. We finally bailed ourselves out too many times, and now there are too many US Dollars floating around. And it has been too long since the last inflationary period, few of us remember what we had to go through to get rid of that inflation. Literally, most people in the US were not alive in 1982.
The bond market is telling us a recession is coming, the futures market is telling us that the Federal Reserve is serious about hiking interest rates until inflation relents. The last time we faced this situation was before most of us were born. “Those who cannot remember the past are condemned to repeat it.”
Then after unemployment has increased by at least half a percentage point within three months (quarter-over-quarter), the recession has already arrived.
But we're only within Month One of the current inversion. Perhaps the inversion won't last the minimum length of time required to cause a recession. We've got about nine months left for interest rates to return to a normal upward-sloping curve. The Fed hasn't always waited 8-10 months before retreating.
As I wrote before, I can't predict what a group of humans will decide in the future. But there is a futures market where investors place bets with real money on future interest rates. The futures market predicts the yield curve will remain inverted through September 2024, which would be for 22 months. This would be the longest yield curve inversion in recorded history. So, the bond market is definitely expecting the Fed to keep shooting until a recession has begun.
-----
But then I read people's opinions about politics, because I'm a political news junkie as well as an econ stats junkie, and I see an incredible disconnect. Nobody in the political world seems to be expecting a recession between now and November 2024. As people handicap Trump vs. other Republican candidates, and people wonder whether Biden will be too old ... nobody seems to get that we'll be in an old-fashioned classical business-cycle recession by then with skyrocketing unemployment and bankruptcies. And unlike the pandemic recession, we won't be able to blame COVID, we won't be able to blame state governors for not reopening their economies or schools or whatever.
And therefore, Democrats will lose the White House, no matter who Democrats nominate, no matter who Republicans nominate. There is no example of a President surviving a recession since at least before the Great Depression.
The actions of the Federal Reserve over the next year are far more important to our political future than the endless nomination processes of the two major parties.
-----
And then there's the stock market. As measured by the S&P 500, it peaked on January 3rd of this year and is down 17% so far. Not a good year for stocks as interest rates have quickly increased. But compared to earnings, stock prices are still about twice as high as they were during the last business-cycle recession (2009), and about four times as high as they were the last time the Fed was battling inflation of 8% (1982).
Anybody paying attention to the bond market and economic history should understand how risky stocks are right now. It would be consistent with both current conditions and economic history for the stock market to fall by 50-75% over the next few years. Yet I see very few people worried about such a tumble, even though cryptocurrencies are down 75% from a year ago. If it can happen to crypto, why can't it happen to stocks?
-----
When my Lyft drivers are giving me stock-picking advice, when the porn stars I follow on Twitter are giving me stock-picking advice ... this is anecdotal evidence of course, but it is still indicative that we're in bubble times. The amazing thing to me of the past 25 years is how we keep on blowing new financial bubbles even after we've witnessed them crashing. Why didn't we learn from the stock market bubble of the late 1990s? Why didn't we learn from the real estate bubble of the late 2000s? Why haven't we learned from the crypto bubble of the early 2020s?
When investors gauge the "value" of an investment by how much it is going up, that's a bubble mentality. The US has been living inside a bubble mentality for 25 years now, and every time a bubble pops we expect the Federal Reserve and the US Treasury to bail us out. And then we experienced a real-life pandemic, the worst in a hundred years, and we reacted by having the Federal Reserve and the US Treasury bail us out, and we bubbled on.
Maybe it's another feature of the Internet, this Age of Serial Bubbles. As the Internet has disintermediated all sorts of prior relationships, it has also put financial bubble participation apps into the hands of each person. You too can buy crypto at the touch of a finger. You too can day trade in ETFs. People used to ask the advice of professional stock brokers, now they trade memes on Reddit and Twitter. Fortunes can be made if you ride the memes upward, but plenty of people have also lost their life savings by betting them on pure fantasy.
-----
But now we've finally re-entered the world of inflation. We finally bailed ourselves out too many times, and now there are too many US Dollars floating around. And it has been too long since the last inflationary period, few of us remember what we had to go through to get rid of that inflation. Literally, most people in the US were not alive in 1982.
The bond market is telling us a recession is coming, the futures market is telling us that the Federal Reserve is serious about hiking interest rates until inflation relents. The last time we faced this situation was before most of us were born. “Those who cannot remember the past are condemned to repeat it.”