by Paul Hoffmeister, Chief Economist
Recent yield curve steepening suggests the US economy is slowing down and could enter recession by mid-2024.
S&P 500 performance is likely to be limited during the next year given the post-2000 history of yield curve steepening out of deep inversions and with the Fed pursuing a “higher for longer” policy approach.
The recent 3.7% unemployment reading doesn’t necessarily prevent a recession from happening soon.
Since July 31st, the S&P 500 has declined more than 6%. But seemingly missed in most market commentary is the fact that the yield curve is experiencing the most aggressive steepening since 2000. During the last 5 months, the spread between the 10-year Treasury yield and 3-month T-Bill has steepened from negative 190 basis points to negative 71 basis points (as of last Friday).
As the chart below shows, the last three recessions began after a steepening from deep inversions occurred. In December 2000, the yield curve reached maximum inversion, and the recession began in March 2001 (3 months later). In February 2007, the yield curve reached maximum inversion, and the recession began in December 2007 (10 months later). In August 2019, the curve reached maximum inversion, and recession began in February 2020 (6 months later).
If the post-2000 relationship between the yield curve and onset of recession is any guide, it’s likely that the next recession in the United States will begin soon; perhaps before year-end or during the first half of 2024. This makes sense considering that interest rate futures are currently pricing in the probability of interest rate cuts in Q3 2024.
Spread between 10-year Treasury/3-month Treasury bill; recession periods highlighted in red. (Source: Bloomberg)
What does this mean for equities? The 2000-2001 and the 2007-2008 steepenings into recession correlated with a weak and declining S&P 500. The 2019-2020 steepening experienced a rising S&P 500 until the Covid pandemic and global shutdown commenced in February 2020, which then triggered both a major equity market selloff and recession. It’s worth noting that by the late summer of 2019, the Federal Reserve had already started cutting rates, which arguably supported equity prices during the second half of that year.
Spread between 10-year Treasury/3-month Treasury bill AND the S&P 500; recession periods highlighted in red. (Source: Bloomberg)
Bottomline: We believe the recent yield curve steepening is further evidence that we are in the early stages of an economic slowdown and contraction. Furthermore, if contraction does occur, history suggests a strong likelihood of weak equity markets during the next year.
Unfortunately, this year’s strong labor market data -- such as September’s 3.7% unemployment reading from the Bureau of Labor Statistics -- seem to be compelling Federal Reserve policymakers to maintain high interest rates for a longer period of time. In our view, these backward-looking indicators are misleading, and the “higher for longer” policy approach is putting a stranglehold on the economy. After all, the recessions of 2001, 2008-2009, and 2020 began when quarterly unemployment rates had just bottomed at 3.9%, 4.7% and 3.6% respectively. A low unemployment rate today doesn’t necessarily preclude a looming recession.
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Paul Hoffmeister is chief economist and portfolio manager at Camelot Portfolios, managing partner of Camelot Event-Driven Advisors, and co-portfolio manager of the Camelot Event-Driven Fund (tickers: EVDIX, EVDAX).
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