The past year has produced several periods of heightened uncertainty and increased financial market volatility. Between the yield curve inverting, tariffs rising, and slightly weaker job growth, you’d be forgiven if you thought the economy was already in the middle of a severe recession. Despite the recent bouts of pessimism, the U.S. economy is still growing at a modest pace and the prospects for the remainder of the year, at minimum, appear reasonable. Yet confusion reigns.
This is evident in the stock and bond markets, which are currently telling two different stories about the future course of economic growth. The stock market is near its historical high and despite increased volatility has performed quite well in recent months. The Dow Jones Industrial Average, for example, has increased more than 10% since the start of the year.
The bond market, by contrast, is signaling a recession. Longer-term bond yields have recently dropped below rates for shorter-term notes (i.e. the yield curve inverted). The inverted yield curve, according to the Federal Reserve Bank of Cleveland, is pointing to a 37.9% probability of recession by September 2020, down slightly from August (45% probability) but up significantly over the past few months. This estimate is consistent with projections from private forecasters, who place a one-in-three probability of a recession in a year. The modest improvement reflects a recent rebound in the 10-year Treasury note. While it remains inverted relative to the 3-month Treasury bill it is now just above the 2-year note, another common metric. Despite some retrenchment, the bond market’s recession call is consistent with private sector forecasters’ estimates of recession probability over the next year.
Part of the uncertainty lies in the analysis of current economic conditions. Real GDP slowed to 2.0% in the second quarter from 3.1% in the first. Although the pace was significantly slower in the second quarter, most of the difference is actually accounted for by a drop in business inventories to a level more consistent with its historical average. Nevertheless, growth will likely not surpass 2.0% through the remainder of the year.
The Chamber would like to see policies that bring growth closer to 3%, but relative to developed countries in the rest of the world, the U.S. economy has been a clear bright spot. This appears to be the primary concern and difference between the stock and bond markets. While the stock market has largely shrugged off international developments, the inverted yield curve is a warning that the U.S. is not immune from slower growth abroad.
Policymakers have already acted to stem further deterioration in sentiment. The Federal Reserve has shown a willingness to offset global weakness through rate cuts and appears ready to cut rates again should upcoming data warrant such a move.
Although the U.S. is faring better than other developed countries, one notable area of concern is that current budget deficits are especially elevated for a non-recessionary period and the debt is on an unsustainable path. In its latest analysis, the Congressional Budget Office projects that debt held by the public will almost double between 2018 and 2029, rising from 78% of GDP to 95.1%. One small bit of salutary news is that the recent budget agreement postpones conflict over the debt-ceiling until 2020. Nevertheless, current debt levels are unsustainable and far too little attention has been given to this issue.
Although recession fears have been rising, as evidenced by another decline in business confidence and resultant drop in the stock market, the U.S. economy has remained resilient. It’s time to give American businesses a renewed reason for optimism by working across the aisle to pass much needed legislation. U.S. Chamber of Commerce CEO Tom Donohue recently proposed three key reforms in his recent Washington Post op-ed. Donohue called for the administration to end the current tariff escalation and negotiate with China for a long-term, sustainable trade deal, Congress should pass the United States-Mexico-Canada Agreement (USMCA), and he wrote that “if Congress really wants to show that it’s committed to keeping the economy on track, it should enact an infrastructure bill. That would boost Main Street confidence in untold ways.”
These policies all warrant bipartisan support and would provide a needed jolt to the economy.