June 7, 2019

A Booming Economy, A Very Nervous Fed, and A Plunging Yield Curve. How Come?

by Hal Gershowitz

Comments Below

Don’t be spooked by economic jargon. Skip to the proverbial bottom line. Investors are becoming very nervous. How do we know that? Because seasoned investors are accepting lower yields on long term bonds (compared to short term bonds). As investors worry about the short term, they invest in longer-term investments to lock in the best available interest rates. This drives the price of those investments up. Because the interest rate is generally fixed, the yield goes down as the price of the bond rises. (For example, if the demand for a bond that paid 2.5% interest and sold for $100.00 on June 1st drove the price of that same bond to $125.00 by July 1st, that same 2.5% rate of interest would, of course, represent a lower yield. Well, today, and for several weeks, the yield on long-term (ten-year) bonds is lower than the yield on shorter-term three-month bonds. Why would any investor accept a lower yield on a long-term investment?  Well, simply stated, because he or she believes there is trouble ahead in the relatively short term.


Well, often, when investors begin to worry, they may eschew stocks and rush to lock in higher, long-term rates by purchasing long-term bonds to ride out the anticipated storm. But about what kind of storm are investors worried? Inflation, which is the kind of storm many investors worry about the most (other than deflation) seems to be nowhere on the horizon.

And our Central Bank, the Fed, really seems to be spooked, with most analysts anticipating a rate cut in the next month. The fed usually cuts rates to stimulate a moribund economy, but the economy, by all measures, seems very strong. Unemployment is at record lows and manufacturing growth is at record post-war highs. So, what is spooking the bond market and the Fed?

To paraphrase James Carville from the Clinton era: It’s Trump’s Trade Wars, Stupid.

It seems pretty certain that the Fed is weighing the toll Trump’s trade war will exact from our economy. That’s something the President should have weighed as well. Oxford Economics estimates that hiking the tariff to 25% on some Chinese imports last month will cost our economy about $62 billion by next year. That’s just under $500 per household. And if President Trump goes ahead with his threat to impose a 25% tariff on all imports from China, that would raise the cost per family to about $800. Our economy would be about $200 billion smaller by 2020.

Then there’s the job market. What toll on US jobs will the current tariff take? Oxford research estimates that the current tariff could result in 200,000 fewer jobs. And if President Trump extends the tariff on all imports from China as he has threatened to do, about 360,000 fewer jobs would be created in the United States.

And President Trump wielded his new tariff stick to prod Mexico to stop the flow of immigrants through that country. Trump no doubt will be emboldened to use his tariff club elsewhere when we have a dispute with another trading partner. The direct costs of these tariffs, both real and threatened are pretty easy to measure. The indirect costs, not so easy. JP Morgan Bank is pushing for two rate cuts before the end of the year because their analysts believe the toll is real and growing that Trump’s tariffs are taking on consumer and business confidence.

President Trump is running the country as he has run his businesses, by the seat of his pants. He takes counsel from no one. He has a history of closing various businesses and leaving untold employees, suppliers, and contractors holding a bag full of accounts receivable. We’ll face yet another need to raise the national debt ceiling in 90 days because we’re now running, for the first time in our history, a trillion-dollar budget deficit.  A trillion dollars. Imagine that!

This all adds up to an incredibly ill-timed decision to go to war— a trade war with, well, just about everybody. History will determine whether President Trump is a skilled and thoughtful negotiator or a bull in a china closet. History’s verdict will take time. The Fed’s contemplation of a cut in interest rates and the ever-extending inverted yield curve suggests, however, that the china is rattling ominously.

All comments regarding these essays, whether they express agreement, disagreement, or an alternate view, are appreciated and welcome. Comments that do not pertain to the subject of the essay or which are ad hominem references to other commenters are not acceptable and will be deleted.

Invite friends, family, and colleagues to receive “Of Thee I Sing 1776” online commentaries. Simply copy, paste, and email them this link— www.oftheeising1776.substack.com/subscribe  –and they can begin receiving these weekly essays every Sunday morning.

5 responses to “A Booming Economy, A Very Nervous Fed, and A Plunging Yield Curve. How Come?”

  1. Roberta Conner says:

    Thank you for the caveat regarding what is occurring in the bond markets and the likely effect on the stock market. Patience may well be a virtue, however, since one of the trade wars (Mexico) has just been resolved successfully and Trump’s rather bold strategy may well work with China.

    I take exception where in today’s article you state”….we are now running, for the first time in our history, a trillion-dollar budget deficit. A trillion dollars. Imagine that!”

    A trillion dollar national debt is nothing new. According to a most recent source, (Newsweek June 9, 2019) “… the highest ever deficit figure recorded during Obama’s presidency was around $1.55 trillion in 2009… The Obama administration ran a deficit above $1 trillion for the next three years…”

    As far as the national debt, according to the Business Insider, “… by the end of fiscal 2024, the last year of Trump’s second term if he wins reelection, the total debt added is projected to come in at $8.78 trillion. As it stands, Trump could add roughly the same amount of debt as Obama over two terms. As a percentage, however, under Obama’s first two years the national debt grew by 33%, and it grew by 84% by the end of the 2016 fiscal year. The debt grew 10% in Trump’s first 752 days and is projected to grow by 44% by the end of the 2024 fiscal year.”

    • Ms. Conner is correct with respect to the gross deficit during the first year of President Obama’s first term and the three years
      thereafter. In our calculation, however, we backed out the costs of TARP 1 (Troubled Asset Relief Program) and Tarp 2 as these costs were imposed,
      rather than proposed, by the Obama Administration. With respect to the first year of the Obama Administration (or any Administration),
      first-year budget costs are primarily the result of the prior Administration’s last year budget costs. In trying to determine the impact of Tarp 1 and Tarp 2 on the Obama budgets we consulted the work of John R. Talbott, Professor of finance at S.P. Jain School of Global Management. According to Professor Talbott the full cost of the bailout included Fannie and Freddie bailout of $700 billion, Eventual FDIC losses, $500 billion, and Credit union guarantees of $50 billion. Professor Talbott included many other imputed costs, and the total cost of the bailout, direct and imputed, totaled over $14 Trillion according to Talbott. We did not include all of these costs, but we did eliminate the first year Tarp budget costs that President Obama inherited from President Bush’s last year budget. We also considered it reasonable to eliminate all of the budget impacts of the bailout from the Obama budgets as his policies were responsible for none of them. Ms. Conner is correct though, that the impact of these costs contributed to trillion-dollar Obama budgets even though they did not result from Obama programs.

  2. susan duman says:

    While the economic statistics and bond predictions are above my pay grade, I think I have observed the following.
    Russia and China are following everything. . They have become more in-sinc as they watch Trump go foolishly after Mexico with ridiculous threats of tariffs.
    Also, I think I observed Powell trying to steer clear of Trump regarding rates. Was that interpretation accurate?

  3. Robert borns says:

    Our nation is in an economic battle with China. The big question is can our form of free wheeling democratic republican government with its bickering selfish political leaders try to really solve our problems or will the Chinese form with a central harsh dictatorship combined with a semi capitalistic business economy survive and suppress us. Place your bets. Bob borns

  4. Perry says:

    It is apparent that Mexico will capitulate on the threat of
    tariffs but that threat with China is a lot more complicated.

    Given the absence of a democratic plan of any kind our
    POTUS has taken some rather risky steps.

    I think it unfair to measure Trump’s business failures with his
    current plans in government. In business as in life sometimes
    you win and sometimes you lose. All in all I see an economy
    continuing booming which absolutely would not have been the
    case with the election of Hillary and company. He so far has
    outsmarted so many naysayers.

Leave a Reply

Your email address will not be published. Required fields are marked *