Bob’s Journal

Another Recession Indicator Stumbles

The yield curve is about to turn positive, and that could mean a widely followed recession indicator gave a false signal for most of the last two years.

The yield curve is a plot of the yields on treasury debt of different durations. A normal yield curve is positively sloped.

The debts with the lowest durations (such as treasury bills) have the lowest interest rates. The rates are higher on longer-duration treasury debt, with 30-year bonds having the highest interest rates.

A negatively sloped yield curve is the opposite. The shortest-term debt has higher yields than longer-term debt.

A negative yield curve usually is caused by the Federal Reserve raising short-term interest rates to slow economic growth and reduce inflation.

Various studies over the years found that recessions usually follow when a yield curve has been negative for a while. The yield curve has been found to have greater than 90% accuracy in forecasting recessions.

That shouldn’t be a surprise, since a negative yield curve usually arises from the Fed’s attempt to slow economic growth.

But, unless the economy drops into a recession soon, it appears the recession indicator didn’t work this time.

The yield curve, as measured by the difference between the yield on two-year treasury notes and 10-year treasury bonds, has been negative for more than 540 trading days, according to Bespoke Investment Group.

That’s the longest period on record that the curve has been negative. Previously, recessions followed when the yield curve was negative for 100 days or more.

With the Fed ready to cut interest rates at its September meeting, market interest rates on short-term treasury debt have been declining. The yield curve isn’t positive yet, but it is close and probably will turn positive in the coming weeks.

Though economic growth has slowed, it appears the yield curve didn’t work as a recession indicator because this time was different.

Economic growth in recent years wasn’t driven by a lot of private sector borrowing stimulated by low interest rates. Instead, the federal stimulus programs and federal borrowing drove the growth.

So, when the Fed raised interest rates beginning in 2022, the private sector wasn’t affected much. Households and businesses could continue to spend, and the economy could keep growing.

Also, the gradual reduction in the federal stimulus caused spending to slowly decline. That, plus improvements in the supply of goods, brought inflation toward the Fed’s target without a recession.

The Fed is now worried enough about a recession that it will reduce interest rates before there’s a substantial decline in the labor market.

Because the Fed wants to avoid a recession more than it wants to bring inflation to its target rate, it will cut rates and help bring about a positive yield curve without waiting for growth to tumble.

Social Security’s Share of Federal Spending Forecast to Increase

The Congressional Budget Office (CBO) issued its latest projections for Social Security.

The CBO issued two sets of projections. One set assumes all promised benefits will be paid even after the Social Security trust fund is exhausted. The other set assumes an across-the-board benefit reduction after the trust fund runs out, which CBO estimates will happen in 2033.

Currently, Social Security benefits are 5.1% of GDP. The revenues from Social Security taxes are 4.5% of GDP and are estimated to remain around that level for the 75-year period of the projections.

The share of GDP going to pay Social Security benefits will gradually increase over the next 75 years, and the gap between the annual Social Security tax revenue and benefit spending also will rise.

By 2098, Social Security benefits will be 6.7% of GDP.

Suppose Congress does nothing after the trust fund is exhausted. In that case, Social Security benefits would decline by about 23% in the first year after the trust fund runs out of money. By 2098, benefits paid would be about 28% less than promised.

It’s likely that Congress will enact some measures to prevent an across-the-board reduction in Social Security benefits. I think we’ll know more after the election, since several groups in Congress are working on reforms they will wait to make public.

But higher income beneficiaries are likely to face a reduction in their benefits. Also, until Congress acts, all retirement plans should have a contingency that assumes benefits might be reduced.

A Record Number of Retirement Account Millionaires

The United States has more people with at least $1 million in their retirement accounts than ever before, according to Fidelity Investments.

The number of 401(k) millionaires increased by 2.5% to 497,000 in the second quarter of 2024, according to the investment firm’s quarterly summary of the data in retirement accounts it administers.

IRA millionaires increased by 6% to 398,594.

The savings rate for 401(k) plans remained at 14.2%, a combination of 9.4% from employee contributions and 4.8% from employer contributions, both of which are record levels for Fidelity accounts.

Generation X is in the peak saving years and appears to be taking advantage of it. The average balance for Gen X savers increased to $554,000 from $543,400 in the first quarter. Also, Gen Xers increased their IRA contributions by 30% from the previous year.

The Data

The ISM Manufacturing Index improved to 47.2 in August from 46.8 in July. But a reading below 50.0 indicates the sector is contracting. The index has been below 50.0 for 21 of the last 22 months.

The PMI Manufacturing Index fell to 47.9 in August from 49.6 in July.

The Personal Consumption Expenditure (PCE) Price Index rose 0.2% in July after rising 0.1% in June. Over 12 months, the PCE Price Index increased 2.5% through both July and June.

The core PCE Price Index, which excludes food and energy prices and is the Fed’s preferred measure of inflation, increased 0.2% in July, the same as in June.

Over 12 months, the core PCE Price Index rose 2.6% through both July and June.

The Consumer Sentiment Index from the University of Michigan increased to 67.9 at the end of July from 66.4 at the end of June.

Before July, the index declined four consecutive months. The index was 69.4 in August 2023.

Sentiment regarding current conditions declined in July while there was a solid increase in expectations.

The sentiment improvement in July came entirely from political independents, who became more optimistic. Sentiment among Republicans declined, but sentiment among Democrats increased an equal amount.

Personal income increased 0.3% in July, following a 0.2% increase in June. Income from assets declined a little in July while compensation increased 0.3%.

Personal spending rose 0.5% in July after climbing 0.3% in June. Spending in July increased for both goods and services. After adjusting for inflation, real spending increased 0.4% in July.

Factory orders increased 5.0% in July, following a 3.3% decline in June. But most of the July increase was in the volatile transportation sector. After excluding transportation orders, factory orders increased 0.4% in July and 0.1% in June.

Pending home sales tumbled 5.5% in July after rising 4.8% in June. Pending home sales in July were 8.5% lower than 12 months earlier compared to 2.6% lower in June.

Gross domestic product (GDP) grew at a 3.0% annualized rate in the second quarter, according to the second estimate. The first estimate was 2.8% growth. GDP grew 1.4% in the first quarter.

A higher estimate of consumer spending was the main reason for the bump in the estimate.

Job openings declined again in July, according to the JOLTS (Job Openings and Labor Turnover Survey) report.

The number of job openings in July dropped to 7.673 million, the lowest level since January 2021.

The number of people quitting jobs fell to 3.277 million, its lowest level since September 2020. A high number of people quitting jobs is considered a sign of a strong labor market.

New unemployment claims fell by 2,000 to 231,000 in the latest week.

Continuing claims, which lag a week behind new claims, increased to 1.868 million from 1.855 million.

The Markets

The S&P 500 fell 1.69% for the week ended with Tuesday’s close. The Dow Jones Industrial Average lost 0.64%. The Russell 2000 dropped 2.46%. The All-Country World Index (excluding U.S. stocks) declined 1.76%. Emerging market equities tumbled 2.34%.

Long-term treasuries gained 0.09% for the week. Investment-grade bonds lost 0.35%. Treasury Inflation-Protected Securities (TIPS) fell 0.27%. High-yield bonds declined 0.29%.

On the currency front, the U.S. dollar rose 1.40%.

Energy-based commodities declined 3.52%. Broader-based commodities lost 2.36%. Gold dropped 1.30%.

Bob’s News & Updates

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