When yields on 10-year Treasury bonds dropped below those on two-year Treasury notes last week, it triggered one of the most reliable harbingers of a coming recession.
Every U.S. recession in the past 50 years has been preceded by a yield curve inversion. The Dow Jones industrial average tumbled more than 800 points Wednesday of last week.
But Yosef Bonaparte, finance director of the J.P. Morgan Center for Commodities at the University of Colorado Denver, argues there is a reasonable explanation for why long-term yields dropped below short-term ones.
Sweden, Japan, Belgium, France, Netherlands, Germany and Denmark are all mired in negative rates, including on their 10-year bonds. Danish lenders are even willing to pay homebuyers to take out a mortgage.
About $16 trillion in global debt now carries a negative interest rate, while U.S. rates remain positive. As more money flows out of negative yield markets, it pushes down the yields for U.S. debt on the long-end of the curve, Bonaparte said.
An argument could be made that foreign investors are buying U.S. debt because they perceive strength, not weakness, in the U.S. economy, he said in a contrarian stance.
So what should investors look to if not the yield curve?
“Consumers are driving the economy,” Bonaparte said. “Consumer confidence is high. We should be OK.”
Target on Wednesday reported both sales and earnings that exceeded expectations, pushing the retailer’s share price up 20 percent. Walmart, Lowes and other retails have shown unexpected strength.
Bonaparte argues that wouldn’t be happening if U.S. consumers, who account for 70 percent of the nation’s economic activity, were retrenching.
When consumers perceive a contraction is coming, they shift more money from spending to savings to prepare for job losses, notes behavioral economist Dan Geller.
Geller has developed a measure called the money anxiety index to measure that shift and it stood at 44 in July, close to the recovery-era low of 42.7 in May.
“These figures are relatively low, and they do not point to an immediate recession,” he noted in his most recent update.
But it wouldn’t take much to get there. Just a 5 percent contraction in consumer spending would be enough to shave 3.5 percent off GDP, turning a growing economy into a contracting one.
Bonaparte argues that some kind of shock is needed to derail economic momentum. In 2001, it was the collapse of unsustainable gains in tech and telecom stocks, while defaults on poorly underwritten mortgage debts were the culprit in 2008.
Bonaparte said he doesn’t see any bubbles in the capital markets, with the exception of cryptocurrencies. Bitcoin has a market value of about $186.4 billion and the other 2,327 crypto-currencies are valued at $88.5 billion, according to CoinMarketCap.
Even if Bitcoin cratered, that would impact only about 40,000 U.S. households. ExxonMobile has a higher market value than all cryptocurrencies combined.
Still, the economist who found the link between yield curve inversion and recessions, Arturo Estrella, told CNBC Thursday he isn’t backing down.
“It’s impossible to be 100 percent sure about the future, but I’d say the chances of a recession in the second half next year are pretty high,” he told CNBC.