‘Very worrying’ sign of severe economic downturn emerges as stock market crashes

Topline

A growing wave of economists are warning that the chances of a recession have risen amid a historic inversion of the yield curve – a telltale sign of an impending economic slowdown after the Federal Reserve raised rates to the highest on Wednesday high level since the Great Recession and signaled its policy would be more aggressive than expected.

Highlights

Yields on the 10-year Treasury jumped more than 10 basis points to a new 11-year high of 3.829% on Friday, while the 2-year Treasury hit a 15-year high of 4.266%, deepening the yield curve inversion at some 50 basis points, the largest spread in more than 30 years.

Since July, the yield curve has inverted – when short-term yields fall below long-term yields – a sign that investors are more bearish about the long-term outlook for the economy, and the inversion does not only deepened after the Fed hiked rates 75 basis points on Wednesday and suggested it could institute another unusually large hike in November.

In a note to clients, Sevens Report analyst Tom Essaye explained that the inversion increasingly “makes sense” because a more aggressive Fed and higher rates that make borrowing more expensive will temper demand and will dampen economic growth in hopes of reducing inflation, but he also warned that the magnitude of the reversal has become “very concerning”.

A 2018 Federal Reserve study found every recession in the past 60 years has been preceded by an inversion of the yield curve, and Essaye says the widening spread between 2-year and 10-year Treasuries “screams that a severe economic contraction is coming”, adding that “everyone should prepare” for a significant economic downturn in the months and quarters to come.

In a Friday note, Bank of America economists said they expected the economy to slide into recession in the first half of next year, with real GDP falling 1% after rising 5% last year, and unemployment reaching 5.6%, which could wipe out more than a year of job creation.

The Fed

Fed officials doubled down on their most aggressive economic tightening campaign in three decades on Wednesday, raising interest rates by three-quarters of a percentage point for the third straight time and pushing borrowing costs to 3.25. %, the highest level since 2008. They originally forecast the fed funds rate to climb only 3.4% this year, they now expect it to climb to 4.4%, suggesting another hike of 75 basis points could be envisaged in October. “With this new alignment between the Fed and the markets, the question now is when and how hard the recession will hit,” says Mace McCain, chief investment officer of Frost Investment Advisors.

Sotck exchange

Stocks plunged deeper into bear market territory after the Fed’s hawkish message as major indexes eclipsed yearly lows on Friday. The S&P 500 is down 23% this year, and Goldman economists predict it will fall another 3% by December and could take more than a year to recoup losses. The tech-heavy Nasdaq has fallen 32% since January, the Dow Jones nearly 20%. “Looking ahead one to two months, we don’t have much conviction on stocks,” says Adam Crisafulli, founder of Vital Knowledge Media. “The feeling is obviously awful.”

housing market

Sales of existing homes fell for the seventh straight month in August as rising interest rates continued to drive away potential home buyers, according to the National Association of Realtors. In a statement, the association’s chief economist, Lawrence Yun, called the housing sector “more sensitive” to Fed interest rate hikes and said weak home sales reflect the escalation in mortgage rates this year, which hit a 15-year high of nearly 6.3% this year. week — driving up the cost of monthly payments on new mortgages by more than 55%, an average of hundreds of dollars a month.

labor market

Despite pockets of the economy already reeling from the Fed’s hawkish policy, the labor market remains firmly solid, effectively justifying aggressive action. Initial jobless claims were little changed this week and continuing claims actually fell slightly. However, many experts say it is inevitable that the labor market will soon begin to cool. “It’s possible for the unemployment rate to creep up and wages to cool without an outright recession, but that’s never happened before,” said Comerica Bank chief economist Bill Adams.

Inflation

Although slowing for a second consecutive month, inflation came in at 8.3%, worse than expected in August, much worse than the Fed’s long-standing target of 2%. Bank of America economists predict that inflation will not return to this level before the end of 2024.

Further reading

Dow plunges 400 points: Goldman Sachs warns stock market rout will only get worse this year (Forbes)

New mortgages, student loans, credit cards: Here’s everything that’s costing more as the Fed hikes interest rates (Forbes)

Fed raises rates another 75 basis points, pushing borrowing costs to highest level since Great Recession (Forbes)

Housing market recession: House prices fall as rates hit 6% – here’s how much more they could drop (Forbes)