Ding Dong, is the Witch Dead? The Federal Reserve Predicts No Looming Recession. But Why isn’t There Celebration?
By: Eric Simantel
For what seems like an eternity, even while we’ve been enjoying a post Covid positive period in our economy (sans inflation); we’ve been waiting for this recession to hit the U.S., wipe out jobs, smack the stock market in the face and cause turmoil across the nation.
But on Wednesday, July 26th, Jerome Powell, the chair of the Federal Reserve said, "Given the resilience of the economy, recently (we) are no longer forecasting a recession."
It's almost seems as if, you as a teenager, who stayed out on a summer night well past curfew (in fact, it was probably close to sunrise when you got home), after you did some questionable (but innocent) things – as you started to sneak in the back door back at home – got spotted by your parent who was retrieving the Sunday morning paper. You made eye contact and quickly but quietly went inside to your bedroom. All of morning passed, then midafternoon, then dinner time came and went. Exhausted from the night before, you went to bed earlier than normal; and certainly, expecting when you woke up Monday – a punishment would be announced. That morning, you poured yourself a bowl of cereal at the breakfast table, expecting your parents to start yelling and questioning your decisions and actions. Then, they sat right down next to you with their toast and coffee. This is it, you thought to yourself – the rage of parent anger is coming. But then something strange happened. Nothing happened. Your parents never grounded you. What the heck, you say? You dare not talk to your parents about it, you know they saw you. So what does it all mean? Well, it looks like you’re safe… for now. The US economy had fun, stayed out well past curfew, but looks like no "punishment" is coming.
Even AI (Artificial Intelligence) is seemingly agreeing with Powell. I decided to join the fun and create a Chat GTP account. I asked “it” if a recession was coming. While it didn’t give a straight answer, it did say there are 9 indicators to look at when forecasting a recession. Here are some of the biggies:
#1: Gross Domestic Product (the outputs of goods created by our county). Our GDP has gone up in every quarter since Q2 2020 (14 straight quarters).
#2: Unemployment. Our unemployment rate in the country is at the lowest rate since 1969. (3.6%)
#3: Stock Market Performance. Not sure why this didn’t make the headlines, but the DOW just tied the record for having 13 consecutive ‘winning days’ (not achieved since 1987) and we are only 2.9% away from reaching the all time high of the DOW set in late 2021.
#4: Consumer Spending and Confidence. June 2023 market the third straight month of increased consumer spending and the Consumer Confidence Index has risen for 12 straight months.
#5: The Housing Market. June 2023 marked the first time since February that nationally, there were more homes pending for sale than in the previous month. “The recovery has not taken place, but the housing recession is over,” said National Association of Realtors Chief economist Lawrence Yun on July 27th.
So, if GDP is high, unemployment is low, the Stock Market is humming, consumer confidence is back, and folks are buying houses - why wasn’t there a ticker tape parade, songs, and dancing happening around the Emerald Palace when Powell essentially announced the wicked recession witch was dead? Essentially he landed his Kansas house right on top of his target – but no one cared?
It’s likely because the open market doesn’t believe him yet. There is a rare phenomenon (that hasn’t made headlines yet) that is occurring that has a perfect correlation to predicting of the last 7 recessions, and its something nerdy (don’t worry, I’ll explain in just a bit) called an ‘Inverted Yield Curve’.
Right now – you can buy treasury bonds in the open market. These bonds become due at different increments of time. You can buy one that pays you back in full (with interest) in 1 year, 2 years, 3 years, 10 years, 20 years, etc. The longer term that you buy, typically the higher the interest rate/rate of return is. That intuitively makes sense.
The reason for higher returns for the longer time period – is that there is less predictability the further out into the future you go. For example, I’m pretty certain what the weather will be like tomorrow – but if you ask me what it will be on this specific date in 10 years – the level of certainty goes way down. When you remove certainty, you introduce risk. In the stock and bond market, to compensate for increased risk – you demand a higher rate of return. No different than a bank charging a higher interest rate to someone with poorer credit. They are a riskier borrower to the bank than someone with an 815 credit score.
Those rates of return are currently flip flopped (inverted). Right now, the longer-term treasury bonds are paying out at a lower rate of return than the short-term bonds (that is the inverted yield curve). This is a signal showing that the open market believes there is more short-term risk on the horizon than there is the risk not knowing the forecast down the road. Essentially, the open market is saying – we see a tropical depression in the Gulf Coast, and we are pretty sure it’s going to be a hurricane, and we are certain it’s going to hit in the next year. Powell is saying that tropical depression is heading out to sea and won’t affect anything substantially.
Who is right? Love him, or hate him, Powell is the Chief of the Federal Reserve for a reason. He is one of the brightest economic minds literally in the entire world. I think the market is still in a position where they are still learning to trust him (myself included) – especially after this pretty bold prediction he made stating that thoughts of a recession are in the rear view mirror. The inverted yield curve clearly suggests that the investment markets believe a storm is coming, but as Powell pointed out, there isn’t any clear evidence on the weather maps to suggest it.
Can it be possible that both the investment markets and Powell are both right? I think so – and that's where I’m currently pointing my economic forecast towards. The (Warren) Buffet Indicator Index suggests that the stock market is overvalued by 50.5%. That potentially means a market selloff is coming and some troubled waters for the banks that might be over leveraged. That said, major stock market corrections have occurred without affecting the jobs market, housing market or consumer spending. So, while your Money Market and 401K may take a hit in the next 12 months, seemingly the economy can continue to move forward because folks will still have jobs. When the US Consumer has a job, the US consumer has proven time and time again that they will spend on everything from homes to vacations to retail.
If there is a stock market correction – this could have a positive impact on mortgage rates. Funds will leave the stock market to find safe harbor in the bonds market (including the mortgage backed securities market), which means lenders won’t have to offer as high of a rate of return to investors – which means rates charged to borrower can go down.
Thanks for reading, and Disclaimer:
My predictions are my own and based on individual research and don’t reflect that of C2 Financial Corporation. If there are 36 super computers predicting the weather, just imagine how many there are used to predict economic conditions! And still, they aren’t always right! Do not use this article as a basis to make financial decisions in your investment portfolio. Only do so with the guidance and advice of a licensed Financial Advisor.
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