Fears of a recession have been receding, although the yield-curve spread between the 10-year Treasury and the federal funds rate remains negative (Fig. 3).
On the other hand, the comparable spread based on the 2-year Treasury yield rather than the federal funds rate remains around zero.
More importantly, there is still no sign of a credit crunch in the US. In our study titled “The Yield Curve: What Is It Really Predicting,” Melissa and I observed that in the past an inverted yield curve didn’t cause recessions. Rather, it often correctly anticipated that monetary policy was too tight and might trigger a financial crisis, which would turn into an economy-wide credit crunch and cause a recession.
The credit-quality yield spread between high-yield corporate bonds and the 10-year US Treasury bond remains low around 400bps (Fig. 4). Commercial and industrial loans have stalled in recent weeks but are at a record high and are up 6.4% y/y (Fig. 5 and Fig. 6).
Meanwhile, lots of US economic indicators continue to show an expanding economy:
(1) Citigroup Economic Surprise Index. The Citigroup Economic Surprise Index (CESI) has rebounded smartly from a recent low of -68.3% on 6/28 to 7.0% yesterday (Fig. 7). While it is based on seasonally adjusted indicators, it continues to show a seasonal pattern of weakness during the first half of the year followed by strength during the second half. Indeed, looking at the past 11 years, we can pick six years where the index bottomed almost exactly midway through the year.
There is a very good correlation between the CESI and the 13-week change in the 10-year US Treasury bond yield (Fig. 8). The CESI is clearly seasonally bearish for bonds.
(Then again, let’s not get too bearish on bonds. The yield is also highly correlated with the nearby futures price of copper (Fig. 9). The latter remains relatively weak, though not so much as suggested it might be by the 131bps drop in the bond yield over the past year. In other words, the bond yield might have gone down too far relative to the weakness in the global economy, as signaled by Professor Copper, the metal with a PhD in economics.)
(2) JOLTS. Friday’s weak payroll employment gain of 130,000 for August remains an outlier. Most other labor market indicators remain very strong. For example, yesterday’s JOLTS report for July showed that quits rose to a record high of 3.6 million (Fig. 10). That’s confirmed by the jump during August in the “jobs plentiful” response of the survey used to construct the Consumer Confidence Index. When workers perceive that there are lots of job openings, they are more likely to quit to change jobs. While these openings are actually down 3.0% y/y through July, at 7.2 million they remain above the number of unemployed workers for 17 months in a row (Fig. 11).
By the way, the JOLTS data also show more employment than does the official payrolls series. We regularly compare the 12-month change in payrolls to the 12-month sum of total hires minus total separations in the JOLTS report (Fig. 12). The former is up 2.2 million through July, or 185,500 per month on average, while the latter is up 2.6 million (also through July), or 213,000 per month on average!
In any case, on Monday, Debbie and I blamed the weakness in payroll employment on a shortage of workers rather than weakening demand for them. Yesterday, the National Federation of Independent Business’s survey of small business owners reported that a record 57% of them said that there are few or no qualified applicants for their job openings during August (Fig. 13).
Inflation Scare Ahead?
Low inflation is “the problem of this era,” said New York Federal Reserve Bank (FRB) President John Williams in a 9/4 speech. Melissa and I agree that low inflation is a real challenge for the major central banks of the world. They have been trying to revive inflation to 2% with their ultra-easy monetary policies for the past 10 years without any success.
But what if inflation makes a surprising rebound? That would certainly shock markets into fearing that the low-interest-rate era might be over. In fact, several funky measures of inflation suggest that inflationary pressures may be mounting in the US already. Might that be what the bond market is starting to discern?
We tend to be traditionalists when it comes to inflation measures, preferring the headline and core readings of the personal consumption expenditures deflator (PCED) rather than alternative indicators—not only because that’s what the Fed most often relies on but also because the alternatives tend to exclude too many price categories that are important to consumers, in our opinion. Let’s dig into the numbers:
(1) Mind the headline & the core PCED. During July, the headline and core PCED inflation rates were only 1.4% and 1.6% y/y, respectively (Fig. 14). The Federal Open Market Committee announced its 2.0% inflation target for the first time in January 2012. The core PCED has achieved that during just six months, from mid-2012 through July of this year. The three-month annualized percent change in the core PCED was 2.2% through July (Fig. 15). It tends to be much more volatile than the y/y measure. The headline PCED was up 1.7% on the same basis.
(2) Don’t mind the alternatives. The Atlanta FRB’s sticky-price CPI is an alternative inflation measure based on a weighted basket of items that change price relatively slowly. It rose 2.5% y/y in July, while the actual CPI rose 1.8%. However, the core sticky (excluding food and energy) increased just 1.6%, while the core CPI rose 2.2%. The headline sticky has not been above 2.5% since June 2018, while the core sticky has remained below 2.0% since September 2016 (Fig. 16).
The Cleveland FRB tracks two of its own alternative inflation measures: median CPI and trimmed mean CPI. These measures exclude the items that change the most in price on a monthly basis. The median CPI excludes all price changes except for the ones in the center of the distribution of price changes. The trimmed mean CPI excludes price changes on the highest and lowest sides of the distribution.
The Cleveland FRB’s median CPI has been on an upward trend since early last year, rising well above 2.0% during that time to 2.9% during July. Its trimmed mean CPI has remained above 2.0% since May 2018, registering a reading of 2.2% during July (Fig. 17).
During his 5/1 press conference, Fed Chair Jerome Powell focused on the Dallas FRB’s trimmed mean PCE inflation rate, which is calculated similar to the Cleveland FRB’s trimmed CPI version, noting that it has been consistently at or above 2.0% since May 2018 (Fig. 18). But Powell’s enthusiasm for the measure seems to have been short-lived. The Fed has since dropped its focus on that figure, obviously crafting its recent monetary policy decisions based on the more traditional measures.
Williams closed his speech by saying that “stubbornly low inflation is a reflection of the broader economic picture—the July rate adjustment [was] an appropriate response to ease financial conditions and support the economy.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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