During August, the ongoing recognition that economic growth is slowing, both domestically and internationally, was reflected in higher volatility in equity markets and declining yields on U.S. Treasuries. Ten-year treasuries saw yields fall from 2.02% at the beginning of August to 1.50% at the outset of September. Two-year Treasuries went from 1.89% to 1.50% during the same period, resulting in a flat yield curve between 10-year and 2-year bonds.
Central banks have been busy positioning themselves to provide additional stimulus via either lower interest rates or asset purchases, or both.
Approximately $17 trillion (42%) of bonds outside the U.S. have negative interest rates. It is no wonder, then, why foreign investors find the U.S. Treasury market attractive, even though our yields are at historically low levels. The continual inflow of money to buy our treasury bonds is putting downward pressure on yields and upward pressure on the value of the U.S. dollar. The reality of negative interest rates is impacting investor behavior and calling into question the reliability of the recession signal being sent by an inverted yield curve.
Additional interest rate cuts anticipated
Additional interest rate cuts by the Fed are now firmly baked into investor expectations. Markets expect another 25-basis-point cut in the Fed Funds rate at both the September 18 and October 30 meetings, bringing the upper target for Fed Funds down to 1.75%. An additional cut in December is also viewed as a near certainty.
At the annual gathering of Federal Reserve governors and bankers in Jackson Hole, WY, Chairman Powell made it clear that the economic concerns that resulted in the reduction of the Fed Funds rate in July are still present, and in some cases have intensified.
GDP revised downward
Recent economic reports have done little to change the consensus view of slower growth. On August 29, we received the second estimate of 2Q-19 GDP showing a slight downward revision from 2.1% (first estimate) to 2.0%. Positives in the report included the strongest consumer spending (4.7%) since 4Q-14, and corporate profits recording the first increase in the past three quarters. Improvement in corporate profits, if sustained, is critical to continued strength of the labor market since business investment remains weak.
Mixed labor market news
The August payroll report released on September 6 was weaker than expected (+130,000 vs. +160,000 expected) and included downward revisions to the prior two months’ data. The August report also reflected some of the temporary hiring related to the 2020 census – without these additional jobs, the report would have been even weaker. On the plus side, a slight rise in average hourly earnings (3.2% year over year) and an improvement in the length of the average workweek suggests that aggregate income growth (the fuel for consumer spending) was basically unchanged from July despite weaker job growth. The unemployment rate was unchanged at 3.7%.
Uncertainty regarding trade policies is causing corporate hiring to slow; however, the overall rate of hiring remains above the level of new entrants entering the workforce (approx. 100,000 per month) so that a tight labor market environment should continue with the unemployment rate moving marginally lower by year end.
What to watch
The importance of the consumer to the U.S. economy cannot be overstated. The consumer accounts for nearly 70% of U.S. GDP. Any softening of the labor market will quickly reverberate through the economy. Monitoring the ongoing health of the U.S. labor market, then, is critical in assessing potential future economic activity. A strong labor market coupled with improving corporate profits would argue against a recession starting anytime soon. One factor that could upset that assumption is increased uncertainty in the business community due to escalating trade tensions.