Markets & Economic Update- Third Quarter, 2019
Summer is upon us and I cannot wait to get to the beach for
vacation. What an amazing ride it’s been
this year for bonds! Interest rates
continued their steep decline into the second quarter. Longer-term interest rates are down more than
a full 1.00% since their highs last November.
GDP was +3.1% in the first quarter of this year, but many are projecting
growth of less than 2.0% for the second quarter. Housing looks weaker, with much lower
year-over-year increases in prices and volatility in new and existing home
sales. Business confidence and
manufacturing fell during the second quarter, mostly the result of trade
wars. China reported growth of +6.2% in
the second quarter, which was the lowest there since 1992. All of this led to interest rates falling
month after month in 2019.
Although business confidence fell from the uncertainty, stock markets
were reaching new record highs on many of indices. One exception was small cap stocks, which did
not fare as well as larger companies, due to the Fed raising rates. Consumers are benefiting as the unemployment
rate is at 3.7% in June, wage growth is at +3.0%, and job openings are
plentiful; there are openings of 7.4 million, which is over 1.4 million higher
than the number of unemployed persons.
The Federal Reserve has expressed concern, through Chairman Powell, that
inflation has not met Fed targets of 2.0% and is at risk of falling. Core PCE has only exceeded 2.0% in eight of
the forty-one quarters since 2009. The
Fed may lower interest rates to give inflation a boost. Think about that for a minute…
Leading Indicators & Yield Curves
The index of leading economic indicators, which forecasts growth six to
nine months from now, has stabilized in the past few months, after a very weak series
late in 2018. The “LEI” was unchanged in
May, after rising by +.1% in April, +.2% in March, and +.2% in February. We should continue to have slow GDP growth later
in 2019, based on this indicator.
The leading inflation indicator, or ECRI future inflation gauge, has
been falling on a year-over-year basis and is forecasting low inflation six to
nine months from now. The “FIG” has been
dropping all year, with year-over-year changes in June of -3.6%, May -3.7%, April
of -2.2%, and March -2.6%. Fed Chairman
Powell, you are right. The forecast for
inflation is that it will be weak. Slow
growth, low inflation, it sounds like a broken record…
One of the best leading indicators for the economy, surprisingly, is the
Treasury yield curve. Steep, or
positive, yield curves predict economic growth and higher interest rates. Inverted curves indicate slow growth, or
recession, to come along with lower interest rates. Flat yield curves show stable rates. We are between the flat and inverted yield
curve now, based on different sections of the curve. The 5-year to 2-year and 10-year to 3-month
yield spreads are now at 0%; the latter was inverted by .20% one month
ago. The 10-year to 2-year spread is at
.26%; this is usually the first spread to invert, yet it remains positive. Today, the yield curve is telling us that growth
is coming under pressure but it is not forecasting recession at this time.
The yield curve can remain flat or inverted for very long periods of
time. For example, the inverted curves
that preceded the two recessions since 2000 remained that way for over a year (average
of 13 months) before steepening. The
spreads of the 10-year to 2-year and 10-year to 3-month also have a long lead
time before signals of a downturn are seen.
The 10-year to 2-year spread inversion precedes a decline in the LEI by
9 to 12 months. Both spread inversions
precede recession by 13 months (as in 2000 for the 2001 recession) to 26 months
(as in 2006 for the 2008-2009 recession).
By the time recession begins, the
curve will be steepening again. Historically,
the Fed has been slow to cut rates after the curve inverts, but Fed Chairman
Powell indicated a willingness to cut rates sooner rather than later. This can prolong the recovery and postpone a
recession. It may also be an
acknowledgement that the last rate increase at the end of 2018 was too much or
that the neutral rate was much lower than they believed. (Thanks to a Zero Hedge article for these
A New Record
OMG, we made it! Economic growth
continues this month, marking 121 consecutive months of growth, setting a new US
record for expansion. We just beat out
the March, 1991 to March, 2001 record of 120 months, making this the longest
expansion since 1854. But we did so with
growth that was unusually slow compared to the prior record. Since June, 2009, GDP has risen a cumulative
+25%, compared to +42.6% from 1991 to 2001.
Job growth was slower as well, with jobs having risen +12% since 2009,
slower than the rate of +17% from 1991 to 2001.
(Thanks to a CNBC article for these statistics).
I am sticking to my forecast of real GDP growth of +2.0% to +2.5% this
year, following +2.9% in 2018 and +3.1% in the first quarter of 2019. Although the economy is looking a little bit
tired, I believe that consumers will continue to spend, with retail sales
rising, albeit with some volatility. Job
growth should continue and increasing wages and falling gas prices will
encourage consumer spending. Inventories
should not contribute as much to growth as they did in the first quarter, so a
ratcheting down to the level that we have experienced since 2011 of +2.2% is a
conservative projection. I am assuming that
businesses rise out of their pessimism, manufacturing and housing pick up, and
that some kind of trade deal with China gets completed. And government spending will continue at high
levels. Inflation should remain below
the Fed’s target of 2% and this will keep longer-term rates low.
Speaking of high government spending reminds me that the biggest issue
in this current economic recovery has been the high amount of debt at all
levels- government, business, and consumer.
As I have written before, high debt levels put a cap on GDP growth, with
low inflation and low interest rates. High
debt keeps the velocity of money low (still at 1.46), which weighs on GDP. Just ask Dr. Lacy Hunt. By the way, we will be seeing him at a
seminar during August!
Recession is likely 13 to 26 months away. We are in a prolonged period of low interest
rates and have been since 2009. The Fed
tried for three full years to break us out of the pattern but they did not ultimately
succeed. We fell right back to
equilibrium, as we always do. We are in
for a period of low interest rates, until recession is behind us. If rates rise in the interim, these higher
rates cannot last. The Fed will ease,
but it is a guessing game as to when. Some
say they will ease later this month.
That’s fine and they will probably follow it with another cut later this
There’s nothing to worry about, right? Nothing that a few days on the beach cannot
Enjoy the summer! Thanks for
reading! DJ 07/16/19
Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with Penn Community Bank and its predecessor since November, 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.