The latest 25 basis point interest rate cut by the Federal Open Market Committee came with the yawn it deserved, though it was one of the most anticipated cuts in recent Fed history. While the small cut did nothing to excite Wall Street and did even less to generate a positive tweet from President Trump, it did flatten the yield curve and, perhaps, put to rest some, but certainly not all, of the chatter about the next recession.
Unwilling to leave well enough alone, Trump’s unexpected call the day after the interest rate cut for another heavy dose of consumer-punishing tariffs on Chinese imports further darkened an already trade-war threatening recessionary cloud. Uncertainty marches on.
Before the rate cut and Trump’s trade war announcement, evidence of recession possibilities had been seen in the yield curve, which for me is the difference between the yield on the 10-year federal note and 91-day Treasury bill. That difference entered negative territory on May 23, thereby taking an inverted position that often precedes a recession. Indeed, prior to the Fed’s action, the Federal Reserve Bank of New York’s recession forecast, which is based on yield-curve inversion, was flashing a warning signal indicating a better than 30% chance of a recession in 12 months, the largest probability since 2009.
Yet while the New York Fed model has been accurate, we must remember that yield-curve inversions are not like planets that just suddenly appear in an otherwise happy sky. No, they are the result of actions taken by the Fed itself. When the Fed raises rates out of concern for what it sees as smoldering inflation, the economy responds by slowing down a bit. More rate increases, more slowing. More slowing leads to less investment demand, and that can lead to reductions in the 10-year yield. So now, after nine Fed increases since 2015 and last week’s cut, the inverted yield curve caved.
But still the question remains: Will we see a recession (two consecutive quarters of negative real GDP growth) in the next 12 months? Based on what we know now, I think not. But I hasten to add that Trump’s love of trade wars isn’t helping a lot. Yes, as indicated by the Fed when announcing the recent interest rate cut, the U.S. economy began to slow significantly in late 2018 and at the start of 2019. While consumer spending continued to show remarkable strength, employment growth, U.S. industrial production and exports weakened.
The Trump administration’s expanding trade war with China, threats of tariffs on Mexican imports, and additional tariff threats on European autos raise even more uncertainty across the manufacturing sector. As a result, we have declining growth in industrial production, where the year-over-year growth rate peaked in September 2018 and has diminished almost every month since then.
We see a similar pattern for total employment, where year-over-year growth peaked in January 2019 and has followed a declining trend afterwards. The same pattern is observed for commercial and industrial loans made by all U.S. banks. Year-over-year growth has been falling since February 2019. Similar weakness is now showing up in transportation action. Year-over-year growth in the Cass freight shipment index, which captures activity for all forms of transportation, began to decline in May 2018, entered negative growth territory in December 2018, and remains there. I emphasize that I am speaking of growth rates in this discussion, not levels of activity.
Having said all this, we must remember that the Trump administration has election year incentives to shovel more coal to the economic engine. More deficit spending, perhaps (let’s hope) even less confrontational trade talk, and continued regulation relaxation should be enough to generate greater than 2% real GDP growth in the year ahead.
But we must recognize that Trump seems to have great affection for doing the unexpected, especially when doing so puts him the media spotlight. This suggests that while we may not experience a recession in the next 12 months, the economic path we travel will not be smooth nor the journey a happy one.
Bruce Yandle is a contributor to the Washington Examiner’s Beltway Confidential blog. He is a distinguished adjunct fellow with the Mercatus Center at George Mason University and dean emeritus of the Clemson University College of Business & Behavioral Science. He developed the “Bootleggers and Baptists” political model.
