U.S. Recession Update

Soft- or hard-landing?

From Tuomas Malinen’s Forecasting Newsletter.

Issues discussed:

• U.S. banks have been easing lending standards, and demand for loans has seen a modest recovery.

• U.S. corporations have effectively de-levered from the Corona-peak, but debt levels remain high.

• The prospects for a ‘soft-landing’ keep on worsening due to high debt levels and deepening issues in the U.S. banking sector.

Before entering into the recession-debacle, I want to comment the U.S. yield curve. There’s has been quite a bit of talk about the yield curve un-inverting,¹ but this actually concerns just the difference (spread) between the yields of U.S. 10-year Treasury Note and the 2-year Note. The 10-year/3-month yield curve, which has been found to be more effective in recession forecasting, continue to hover in a deeply inverted territory. What is interesting, is the de-coupling of these two occurring for the first time while inverted.

The differences between the yields of U.S. Treasuries with 10-year and 2-year maturities, and 10-year and three month maturities. Source: GnS Economics, St. Louis Fed, NBER

The likely reason for this is that the U.S. Treasury has been issuing mostly bills (with maturity ranging from few days to a year).² This has pushed the (relative) price of 3-month paper down, increasing its (relative) yield. The Fed buying/selling has also had an effect. This figure presents the Treasury Notes and Bills held by the Fed.

Holding of Treasuries by the Federal Reserve categorized according to their maturities. Source: GnS Economics, St. Louis Fed

The Fed stopped rolling off Treasury Bills in April, while it kept rolling off Treasury Notes with 1-5 year and 5-10 year maturities. This indicates that the supply of 3mo bills was subdued, with respect to 2y and 10y Treasuries. This would have pushed the price of 3mo bills up and yields down (relatively), implying that without the Fed action the inversion of 10y/3mo would have been even steeper.

What the above implies is a direct manipulation of the U.S. bond markets, with the possible aim of keeping the 10y/3mo yield curve from un-inverting. Whatever the reason, it indicates that the 10y/3mo yield curve should not be used in recession forecasting at current time. Yet, the un-inversion of the 10y/2y yield curve sends a (somewhat credible) warning of a recession.

The metrics, I have been using to assess the path of the U.S. economy going forward, show a modest improvement. Yet, outlook of the U.S. economy continues to be dire, due to high debt levels and increasing fragility in the banking sector.

Consumer lending recovers, somewhat