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Minds on the Markets
Archive: January 8, 2024
Yield Curve Inversion’s Crystal Ball
The waiting is the hardest part. But how long must we sit in patient anticipation for a recession that never arrives? Well, let’s get one thing straight: we did have two consecutive quarters of gross domestic product (GDP) contraction in 2022. Somehow, the universal recession definition got dumped, forgotten, as if it wasn’t on everyone’s freshman year Econ 101 midterm exams. Whatever happened, here we are, in 2024, still waiting for the National Bureau of Economic Research (NBER) to call a recession. In 2024? The odds are rising.
The ISM Services PMI decided to ring in the New Year by dropping a downside surprise on us late last week. The previous month’s reading was 52.7, and the consensus penciled in more stability, predicting a figure of 52.5. December’s reading was 50.6, perilously close to 50, the line of demarcation between expansion and contraction. It is disconcerting, to say the least, because Services’ smaller cousin, the Manufacturing PMI, has been in recession for 16 straight months. It has been the former’s resilience that many used to explain away the trouble in the latter.
Still, though the services sector may be near contraction, it isn’t there yet.
There are some history lessons to be learned by looking at a less-common measure of yield curve inversion than the oft-cited interrelationship between 10-Year and 2-Year Treasuries. Consider the interaction between long bonds and t-bills.
On our very long versus very short gauge of curve inversion, for 13 months, the market has been warning of a services recession when long-dated yields first cross below short-dated ones. In the turn-of-the-century recession, the ISM Services gauge waited 19 months after the first moment of inversion before it carved out its cycle low. When it went inverted in early 2006, the stock market decided to run for nearly two more years, while ISM Services kept its downward trajectory for 33 full months. Then we have the COVID-19 era, which messed up all our charts. Inversion occurred, and then we only had to wait eight months for ISM to hit a low during the lockdowns.
The tough part is figuring out whether 19, 33 or eight months is the “best” guidepost for gauging the lag between when inversion first occurs and when ISM Services finds a trough. But because the situation is 13 months deep right now, it leaves us wondering if the next step is a move south of 50. Unless manufacturing obtains solid footing soon, the market may soon have to contend with both ISM gauges being in contraction in tandem.
Additionally, a ton of strategists were taken aback by one of the subcomponents’ plunges: employment tumbled to 43.3. Charles Schwab’s Liz Ann Sonders made a stir by pointing out that that level “was actually never reached in the 2001 recession” because it is lower now.
But macro is never easy. The payrolls report was also released Friday. The 216,000 jobs added last month marked a pleasant surprise. Additionally, the unemployment rate thus far is like the old Energizer Bunny—it keeps going and going and going—in full employment territory. Time will tell if the egg being laid by the ISM’s employment subcomponent smacks that around.
Meantime, the Conference Board Leading Economic Indicators Index has registered a 20-month deterioration streak. That is exceeded only by the 22 months registered from 1973 to 1975 and 24 straight months in the global financial crisis.
Only time will tell if 2024 will bring a soft landing, a hard landing or no landing. Intriguingly, there are a lot of investors who have waved off recession risk; we are not sure why. Inversion has only been in tow for 13 months. The risk is that this is the year the yield curve’s crystal ball gets vindicated.
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