My Buddies, They Wrote Me A Letter

The Biden-Harris administration has made much of a letter signed by 16 Nobel prize-winning economists in late June "warning that the U.S. and world economy will suffer" if President Trump wins another term in the White House (Reuters). The letter says that the economic agenda of President Biden is "vastly superior" to that of President Trump. It goes on to say that Trump's plan to impose tariffs on China again would cause rampant inflation, leading to higher prices on imported goods. "We believe that a second Trump term would have a negative impact on the U.S.'s economic standing in the world, and a destabilizing effect on the U.S.'s domestic economy.," the letter stated.

President Biden referred to the letter during the disastrous debate performance that ultimately led to his ouster from his re-election campaign by the Democrat Party machine, and it was a topic he brought up during several of his subsequent rare public appearances. No doubt Vice-President Harris will make it a part of her campaign repertoire, assuming the Party machine allows her to remain the presumptive nominee.

I'm going to debunk that letter in this post. I'll start with facts and data - something those 16 Nobel laureates curiously left out of their letter - then I'll discredit the signatories to the letter itself, for they are not impartial, and they violated a couple of the cardinal rules of economics in writing the letter.

***************

Let's start by looking at Trump's economic agenda, then we'll contrast that with the agenda we could likely expect from a President Harris, which we can assume would be pretty close to that of President Biden, although Harris has yet to articulate an economic agenda of her own.

The beauty of the task set before me is that I have history on my side: Donald Trump has already been President for one term. And his economic agenda for the next term is really little different than it was for his first term: cut taxes and regulations, adopt an all-of-the-above energy policy to make America energy dominant, and yes, impose tariffs on those countries that engage in unfair trade practices with the U.S., especially those who impose tariffs on our goods and services.

Trump did all of that during his first term, so we have a rich data set by which to measure the results. We can see whether economic growth resulted, and we can see whether those policies ignited inflation, or hurt America's economic standing at home or abroad. I will present data to support my conclusions, unlike the Nobel laureates who penned the letter back in June.

One caveat is that Trump's economic record was interrupted by the economic shutdown that was implemented in response to covid, which caused an outsized, anomalous recession. However, it was very brief, and the recovery was rapid and robust. So we will look at President Trump's economic record both before and after the shutdown.

Taxes

In 2017, the Trump administration put forth the largest overhaul of the U.S. tax code in three decades. The legislation, known as the Tax Cuts and Jobs Act (TCJA), took effect on January 1, 2018. Its primary features were as follows:

• Cut the corporate tax rate from 35% - which in 2016 was third-highest in the world - to 21%.
• Cut the top individual tax rate from 39.6% to 37%; the 33% bracket to 32%; the 28% bracket to 24%; the 25% bracket to 22%; and the 15% bracket to 12%. The 35% and 10% brackets remained unchanged.
• Raised the standard deduction for single filers and married couples filing jointly significantly, eliminating the need for many itemized deductions.
• Suspended the personal exemption.
• Ended the individual mandate under the Affordable Care Act, which imposed penalties on those who did not purchase health insurance under the Act.
• Increased the Child Tax Credit and created a credit for non-child dependents, with income qualifications.
• Raised the estate tax exemption.
• Limited the mortgage interest deduction to $750,000 of debt vs. $1,000,000 previously.
• Suspended some miscellaneous itemized deductions.
• Capped the deduction for state and local taxes.

(Note that the Act was widely criticized for cutting the top bracket rate by more than the next two brackets. However, those in the top bracket tend to be business owners who create jobs, vs. the next two brackets who include more individuals who are merely wealthy earners, which was the rationale for the relative magnitude of the cuts for the top three brackets.)

To measure the effectiveness of the TCJA, we should look at three things:

1. Labor market metrics - as the name implies, the Act was intended to spur job growth. (We'll look at this only up to the covid shutdown; job recovery after the shutdown was largely a function of re-opening the economy.)
2. Economic growth, as measured by GDP growth.
3. Stock market performance - cutting corporate tax rates would benefit publicly-traded companies, and if their stock values increase, the wealth of Americans would also increase; not only wealthy investors but teachers, nurses, union members, and others whose retirement savings are invested in mutual funds, exchange-traded funds, and pension funds, the largest holders of U.S. equities in the world.

Under the Obama-Biden administration, nonfarm payroll growth averaged 121,000 jobs per month. However, during the early months of the administration, payrolls were still declining sharply due to the Great Recession of 2008-09, so let's just look at President Obama's second term. During that time, payroll growth averaged 216,000 per month.

In 2017, prior to the effective date of the TCJA, payroll growth averaged 171,000 per month. From the effective date of the Act to the covid shutdown, payroll growth averaged 184,000 per month.

Thus it's inconclusive whether the TCJA resulted in greater job creation. However, there are a lot more variables involved in job creation than just taxes. Also, payroll growth was gaining momentum in late 2019 and early 2020, averaging more than 200,000 per month, so assuming there would be some lag between the effects of lower taxes and job creation, it could be argued that the TCJA had some effect. Note also that job recovery and growth from the Great Recession had matured, and we were approaching full employment. At that point in an economic cycle, job growth always slows. So we need to also look at the unemployment rate.

The jobless rate under the Obama-Biden administration was similarly skewed by the early months, when unemployment was still very high due to the Great Recession, so again let's just look at the second term. During that time, the unemployment rate averaged 5.8%.

In 2017, prior to the TCJA, it averaged 4.3%. (To be fair to Obama, it had been declining throughout his second term - and there's that evidence that we were reaching or had reached full employment, which Obama's Fed Chair, Janet Yellen, had defined as 5%. This explains why job growth was slowing.) 

From the effective date of the TCJA until the month prior to the covid shutdown, the jobless rate averaged 3.8%, reaching 3.5% in February 2020 - which at the time was the lowest rate since 1969. Also, unemployment among minorities was at record-low levels. Jobless claims were also at levels not seen since the 1960s.

As for GDP growth, during the second Obama-Biden term, it averaged 2.48%. For 2017, it was 2.96%. From the beginning of 2018 up to the covid shutdown, it averaged 2.63%. So again, an inconclusive result; but again, there are more moving parts at play than just taxes. (And, I should note, some of the rapid and strong recovery from the covid shutdown, both in employment and in output, undoubtedly owes to the favorable tax environment.)

Finally, let's look at stock market performance, specifically, the S&P 500 Index. It's hard to place much weight on market performance during President Obama's term, because the market was still being supported by the Fed's Quantitative Easing program through 2014, halfway through his second term. However, the average annual gain in the S&P during that term was a little under 13%.

In 2017, it was 18.6%. From the TCJA effective date until just before the covid shutdown, it averaged 9.75% per year. Again, this is inconclusive, and again, there is much more to stock market performance than taxes (in fact, taxes play a much smaller role than other factors, including regulations). However, it's noteworthy that in early 2020, just before the covid shutdown, the S&P 500 hit an all-time record. Also, despite a 19% decline in March 2020, when the economy was shut down, the S&P eclipsed that record in August, just five months after the shutdown, and had reached a new record by the time President Trump left office. The index returned 16.3% overall for 2020, in spite of the shutdown, and arguably some of that was the result of a favorable tax environment.

Perhaps the best measure of the effects of the TCJA is to answer the question Ronald Reagan posed in his campaign for President in 1980: "Are you better off today than you were four years ago?" In economic terms, very few Americans could honestly answer that question "no" in October 2020. Virtually all of us were paying less in taxes. Our investment portfolios were doing better. There were more jobs, and unemployment was lower, at least until covid hit. Even after covid, taxes were lower and investment returns were higher, and output growth had recovered to 99% of its pre-covid level.

It's harder to measure the effect of cutting regulations, so I'm not going to address that here, other than discussing energy policy below. Suffice it to say that cutting regulations benefits businesses, which is good for job growth, stock market performance (again, benefitting both large investors and small retirement savers), and economic growth and competitiveness. One example of cutting regulatory red tape under the Trump administration was Operation Warp Speed, which got the covid vaccine developed, approved, to market, and ready for global distribution in well under a year. This enabled the Biden administration to be ready to respond to covid (although they initially fumbled the distribution plan), and it's responsible for much of the economic growth of 2021, as it allowed more sectors of the economy to re-open. After 2021, the economy began to contract.

Energy

There are also a lot of moving parts to energy prices. However, prior to the Trump presidency, America was heavily dependent on foreign oil. We saw the disastrous effects of that during the Carter years. And while the Obama-Biden and, to an even greater extent, the Biden-Harris administrations have attempted to push the nation toward "green" energy, there are a multitude of problems with attempting to make those sources our primary sources of energy today.

First, the world still runs on oil. Attempting to change that overnight, rather than gradually, is a fool's errand. Second, the infrastructure does not exist today for green energy to be a primary energy source. We don't have the electrical grid to support widespread ownership and operation of EVs. There aren't nearly enough charging stations, and the Biden-Harris administration's $7 billion investment in building 500,000 charging stations within eight years has only resulted in 12 new stations in two years. Third, EV technology is expensive, and it can't scale fast enough to become affordable. Fourth, EV technology isn't sufficient for most Americans' needs. EVs' limited range won't accommodate most Americans' travel preferences, and there are risks in the event of evacuating from events like hurricanes, operating them in severe winter weather, etc. And finally, green energy isn't that green. The fossil fuels required to produce an EV battery or a wind turbine are greater than the carbon footprint savings, and disposing of them creates more environmental harm than the benefits they provide.

President Trump immediately adopted an all-of-the-above energy policy upon taking office in 2017. I'm not going to look at energy prices post-covid, because a lot of the downward pressure on prices after the pandemic resulted from a severe decline in demand, as air and cruise travel were decimated and there were a lot fewer Americans on the road. (I know - I went on a driving vacation in June 2020, and it was pretty much just us and the tractor-trailers.)

West Texas crude oil prices only fell by about $1.60/barrel from February 2017 to February 2020, but part of that was because we were drilling a lot more oil and selling it abroad. Gas prices from the time President Trump took office until the covid shutdown averaged $2.58/gallon, vs. more than $3/gallon for the seven years prior (discounting the first year of the Obama-Biden term due to the dampened demand from the Great Recession).

(I'm getting ahead of myself, but gas prices under the Biden-Harris administration have averaged about $3.50/gallon.)

From 2017 to 2020, the U.S. was the #1 oil producing country in the world, higher than Saudi Arabia or Russia. We were still the top producer of oil in 2023, but our production had fallen 32% from 2020, and Russia had surpassed Saudi Arabia. We were energy independent when President Trump left office, and moving toward energy dominance. Our Strategic Petroleum Reserve was 638M barrels at the end of 2020. Again, I'm getting ahead of myself, but today, it's less than 367M barrels, down more than 42%. We are no longer energy independent.

Tariffs

This is the hot button, the item that the Nobel laureates claim will cause inflation to spike. Let's look at the record, because Trump imposed tariffs in his first term.

In January 2018, President Trump imposed tariffs on solar panels and washing machines. The tariffs were steep - 30-50%. In March, he imposed tariffs on steel and aluminum imports from most countries, ranging from 10-25%. The administration also increased tariffs on Chinese imports.

Some trade partners implemented retaliatory tariffs, including Canada, India, and China. The Trump administration responded by using the Commodity Credit Corporation to provide aid to U.S. farmers. The administration threatened additional tariffs on Mexican imports to stem the tide of illegal immigrants, but those tariffs were averted through negotiations. (It worked, as Mexico cooperated in stopping immigrants at its border through the Remain in Mexico agreement, and illegal immigration fell by 50% as a result. We know what's happened since - and what the results have been. An estimated 50% of job growth today is due to illegal immigration, at the expense of U.S. workers.)

In December 2019, the U.S. and China suspended a portion of their tariffs, then a month later signed a trade agreement that resulted in the tariffs being further reduced in February and March, 2020.

So, did the tariffs cause inflation from 2018 to 2020? Again, we'll exclude the post-covid time period, since reduced demand and opportunity to spend during and after the shutdown dampened prices.

The month after Trump took office, CPI year-over-year was 2.8%. In February 2020, just before the covid shutdown and when the tariffs had largely been suspended and/or reduced, CPI was 2.3%. The highest annual rate of inflation during the time the tariffs were in place was 2.9%, one-tenth of a percentage point higher than when Trump took office. The lowest rate was 1.5%, in January and February 2019, when the trade war was at its peak - roughly half the rate of inflation when Trump took office, and nearly a percentage point lower than when the tariffs were put in place.

Clearly, the tariffs did not cause an inflationary spike. Further, GDP grew, unemployment fell, the stock market rose, and illegal immigration declined.

Conclusion

It's inconclusive whether Trump's tax policy created jobs, increased output growth, or increased stock market returns, but there are many variables involved in those measures of economic performance. We do know that jobs grew, unemployment fell, GDP rose, and the stock market reached record levels during his term, in spite of the covid shutdown. We also know that Americans' after-tax incomes were higher.

It's clear that his energy policy reduced gas prices and made America energy independent. And it's unequivocally clear that his tariffs did not result in higher inflation. Trump's policies certainly didn't have an adverse impact on America's economic standing in the world, nor did they destabilize the domestic economy (unless you want to count the decision to shut down the economy in response to covid, but we can largely thank Fauci and Birx for that, and besides, his policies brought the economy back to near-full recovery before he left office, as I outlined in my most recent post).

Now, let's turn our attention to what we might expect from a Harris economic agenda. As noted, we really know nothing at this point about what her plans would be, assuming the party machine even allows her to remain the presumptive nominee. Only the polling results will tell.

We do know that she has been in lockstep, to a degree, with President Biden's policies over the last three and a half years. We also know from past statements that she is even more opposed to fracking and more committed to green energy than her boss has been. So about the only thing we can conclude is that we'd be looking at four more years of Bidenomics, but possibly with a booster shot.

So what have we experienced as a result of Bidenomics in terms of the measures above? Well, we've had job growth, but as I've written extensively, that's still just job recovery from the covid shutdown, because we're still about four million jobs short of where we'd be in terms of normal growth had the economy not been shut down in the first place. And as noted, it's been aided and abetted by illegal immigration.

We do know with certainty that taxes would go up, because most of the provisions of the TCJA are scheduled to expire at the end of 2025, including the cuts to the corporate tax rate and the individual brackets, as well as the increase in the standard deduction and the elimination of the personal exemption. So, unless Congress and the new President take action to make those cuts permanent next year, the 2026 tax brackets will revert to their pre-2018 levels.

That means a tax increase for nearly every American, and a return to a corporate tax rate that is among the highest in the world, which would almost certainly result in a sharp correction in the stock market, hurting small and large investors alike. If you're a teacher or a nurse or a truck driver, your retirement savings will take a hit - and so will your take-home pay.

President Trump has vowed to fight to make those tax cuts permanent. In fact, he wants to cut the corporate tax rate further, to as low as 15%, and to eliminate income taxes on tips.

(As an aside, there is a meme floating around social media claiming that this plan is intended to allow lawyers and hedge fund managers to get their large bonuses re-classified as tips so that they're not taxable. America, how ignorant are you? This would be a blatant violation of wage and hour laws. It simply can't happen. Wise up.)

On the other hand, Congressional Democrats are determined to allow the TCJA to expire as planned, and President Biden has said he would veto any legislative effort to make it permanent. We can only assume a President Harris would do the same.

Under President Biden, GDP slipped into negative territory in the first two quarters of 2022, and the 2024 Q1 reading was below 1.5%. The advance release for 2024 Q2 was better, at 2.8%, but is expected to be the highest level of the year (and note that the advance release for Q1 was revised downward in the later releases). Clearly, we're tilting toward recession. Maybe the Powell Fed can engineer a soft landing in the event of a Harris victory, but otherwise, a recession appears inevitable. Trump's agenda is pro-growth, pro-business, and pro-jobs, providing a better chance of a return to growth without relying on monetary accommodation that could result in another bubble.

I already noted what's happened to gas prices under President Biden, and that would be likely to continue with Harris' staunch opposition to fracking and commitment to green energy. We'd likely see a doubling-down of the commitment to phase out gas vehicles and force Americans into EVs. A recent study of EV owners found that nearly half of U.S. EV owners plan to switch back to gas vehicles with their next auto purchase - assuming they can. Ford missed its Q2 earnings estimate by a significant margin due to massive losses on EVs, so corporate America will suffer if the EV-only push continues. China will prosper, and Americans will continue to drive their used gas-powered cars.

We've also seen a huge spike in inflation under the Biden-Harris administration: prices are up about 20% since they took office, even though the rate of inflation is down from the peak of 9% year-over-year in mid-2022. What's worse is that they don't seem to understand what inflation is; as the rate of inflation has fallen, they insist that prices are down. They're not. They continue to rise, but at a lower rate than two years ago (but still at a higher rate than under the previous administration, tariffs and all).

Now that we've thoroughly debunked the letter penned by these 16 Nobel laureates, I'm going to discredit them.

First, let's address the Nobel prize itself. Several noted economists - Franco Modigliani, Merton Miller, Harry Markowitz, William Sharpe, and Eugene Fama - were awarded the Nobel Prize for their work in various market pricing theories. I've studied this work extensively, and much of it is solid. However, a good portion of their work - especially that of Fama - is based on the Efficient Market Hypothesis (EMH), the notion that markets are efficient. I won't go into EMH in detail, but suffice it to say that it's wrong.

Markets aren't efficient. I knew it intuitively when I studied Fama et al during my Chartered Financial Analyst (CFA) studies, and based on my own research. But smarter people than I have debunked Fama's work, and have themselves received the Nobel prize for doing so (Robert Shiller and Richard Thaler). These aren't the only instances of Nobel prizes having been awarded for work that was subsequently proven wrong. Science and literature provide other examples. But Fama didn't have to surrender his Nobel prize.

And let's not forget that the Nobel Peace Prize was awarded to a freshman President whose only contribution to global peace at the time was a world tour during which he apologized to foreign leaders for America being ... America.

But as far as these 16 Nobel laureates who wrote the letter in June regarding Trump's agenda vs. Biden's, they broke two cardinal rules of economics. First, they didn't use data to support their conclusions, as I've attempted to do above. They easily could have, and probably more eloquently than I, though they'd have had to have reached a quite different conclusion than they did, because the data contradicts their assertion.

Second, and more important, they did not adhere to the requirement of political agnosticism in forming an economic opinion or forecast. You see, eight of those 16 economists have made financial contributions to the Democrat Party, and four of them contributed directly to President Biden's campaign. (Not one of them has contributed to the Republican Party, or to President Trump.)

In other words, they're biased.

Sure, I have my political opinions, and I vote, as I assume every economist does. I did note above where the data was inconclusive. And I've criticized Trump for caving to Fauci and Birx and allowing the economy to be shut down. But I go where the data leads me. And I've never donated money to a political party or candidate.

This was a curated, hand-selected list of economists, recruited by the Biden-Harris campaign to pen this letter, without a shred of credible evidence or data to support it. It's no different than the curated lists of pre-screened reporters who are given pre-selected questions to ask in advance of the rare press appearances President Biden has made over the past four years.

So there isn't an ounce of credibility in this letter. We need only to look at the records of these two Presidents over the single term each of them served, and extrapolate it over the next four years (assuming the proxy of one of them continues his policies).

One would bring economic growth, lower unemployment across a broad socio-economic spectrum, lower taxes, low inflation, low energy costs, energy independence and/or dominance, and increased overall financial and retirement security.

One would bring economic stagnation (because output growth is slowing), increasing unemployment (because job growth is slowing and unemployment and jobless claims are rising), higher taxes beginning at least in 2026, higher energy costs and continued energy dependence (including on our enemies), and reduced prosperity.

The choice is yours.

The Truth, The Whole Truth, And Nothing But The Truth

Another election season is upon us, and so it's time for the Curmudgeon to get back in the saddle once again. But this post won't be about politics - at least, not overtly so. True to his roots, the Curmudgeon will take on economic data in this post, setting the record straight, as is his wont. For there's been a lot of misinformation as of late, and the record needs setting straight. As always, we will use hard data to do that.

It's been an interesting three or four weeks, to say the least. First, we had the disastrous debate performance by President Joe Biden, leaving us to wonder just why he insisted on debating his opponent in the first place. That led to a growing chorus of voices calling on him to step aside and let another candidate take his place at the top of the Democrat ticket, as his poll numbers, already flagging, slipped further.

Then, we had the Supreme Court immunity decision that effectively ended much of the lawfare waged against former President Trump, adding to the momentum of his campaign. Less than two weeks later, a would-be assassin's bullet grazed the former President's ear, coming within inches of ending his life, and leaving many questions regarding the Secret Service's security protocols - questions that remain unanswered more than a week later, despite a Congressional committee hearing for which the Director of the Secret Service had to be subpoenaed to appear, only to resign in disgrace a day later.

The following week brought the Republican National Convention, and the announcement of Ohio Senator J.D. Vance as Trump's running mate. These events further solidified the Trump campaign's momentum, and intensified calls for President Biden to step down. In the midst of the RNC, and just two days after the assassination attempt, a Federal judge threw out the classified documents case against Trump, arguing that the Special Prosecutor in that case - who would also preside over other lawfare cases against Trump - was unconstitutionally appointed. Further momentum for Trump.

Finally, three days after the RNC, and just over three weeks after the fateful debate, President Biden announced that he would not seek re-election - ironically forced out of the campaign by the Democrat Party machine that made him the 2020 nominee after forcing then-frontrunner Bernie Sanders aside, and for the same reason: the party machine determined that its frontrunner could not defeat Donald Trump, the will of the voters be damned.

Now, you might say, what does all of this have to do with economics, EC? It's sounding a lot like politics to me. Well, dear reader, read on. This is merely the backdrop. The misinformation, and the economic data that will disprove it, is forthcoming.

***************

The Misinformation

The initial misinformation came during the debate itself, when President Biden claimed that he inherited an economy that was on the brink of disaster following the covid pandemic, and that he brought America out of the pandemic.

But the catalyst for this post came in the aftermath of President Biden's announcement of his "withdrawal" from the campaign.

A teary-eyed Rachel Maddow - purveyor of more conspiracy theories and misinformation than the Kremlin itself - proclaimed that Biden had brought America from the dark depths of the economic disaster wrought by covid, implying that he took office at the nadir of the pandemic's economic malaise, and lifted the U.S. economy to recovery.

Well, as Col. Sherman T. Potter would say, "Horse-hockey."

Let's look at the data by sector. But before we do, I will, in the spirit of political agnosticism that any economist worth his or her salt should embrace when discussing economics, place blame for the covid shutdown at the feet of President Trump. He allowed Fauci, Birx, et. al. to convince him to allow the states to shut down their economies, the most disastrous policy decision in the history of disastrous policy decisions, a wholly unnecessary move that accomplished nothing in the way of public health but did nearly irreparable harm to the global economy, a move whose repercussions are still being seen in the economic data today. (To be fair, it was a decision - we now know - based on bad science, or no science, from the man who claimed he was science itself.)

There is a constitutional argument to be made that the decision to shut down economies was rightfully a states' rights decision. I would argue that given the gravity of the repercussions, for the good of the Republic, the federal response should have superseded states' rights at the time, something that Fauci, Birx et. al. themselves argued in trying to shut down ALL states. Trump and Pence unwisely followed their bad advice, permitting the calamitous "Two weeks to flatten the curve" lie, which turned into nearly two months, with disastrous results.

As a reminder, covid hit the U.S. in March 2020. The U.S. economy was shut down from mid-March through April, and re-opened in early May. Donald Trump was President at that time. Joe Biden was not even the presumptive Democrat nominee until Sanders was officially pushed out of the race on April 8, and he didn't secure enough delegates to become the nominee until June 5, having finished lower than third in the Iowa caucus and New Hampshire primary. So he had nothing to do with the economy from the time it re-opened in May 2020 until after his inauguration in January 2021.

On to the data.

Employment

As I've noted before, the covid shutdown eliminated nearly 22 million U.S. jobs. Every job gained since then has been recovered, not "job growth." (All 22 million jobs were recovered by June 2022, but that doesn't account for the normal growth that would have occurred had the economy not been shut down; it was growing by about 200k jobs/month prior to the shutdown, with no indication of slowing. Had growth continued at that pace, we'd still be about 4 million jobs ahead of where we are today.)

In the nine months from when the economy re-opened in May 2020 until the end of President Trump's term, about 12.5 million jobs were recovered, or about 57% of the jobs eliminated - and that includes the 243,000 jobs lost in December 2020, when California and New York shut down their economies for a second time. So President Trump got payrolls 57% of the way back to where they'd been before the shutdown.

How long did it take for President Biden's administration to oversee the recovery of the remaining 43% of jobs eliminated? Seventeen months, about twice as long as it took President Trump's administration to get us 57% of the way there. And how long did it take for the Biden administration to oversee the recovery of 12.5 million jobs, a feat the Trump administration achieved in just nine months? Three times as long - 27 months.

Let's look at another employment measure: the unemployment rate. President Biden likes to boast that the unemployment rate today is the lowest in U.S. history. (It's not - at 4.1%, it's not even the lowest in his term; that number is 3.4%, recorded in January and April of 2023. It's risen steadily this year.) But the lowest unemployment rate in U.S. history is 2.5%.

Moving on to the covid recovery numbers: in February 2020, just prior to the pandemic, the unemployment rate was 3.5% and trending lower; it had dropped from 4.0% at the beginning of 2019. (It averaged 7.4% under the Obama-Biden administration, and was 4.7% when Trump took office.) In April 2020, it peaked at a record 14.8% due to the shutdown.

By the time Trump left office, the unemployment rate had dropped to 6.4% - a decline of more than eight percentage points, and lower than the average under his predecessor.

How many percentage points has it declined under President Biden?

Just over two. Three, if you count the lowest point during his term. Again, Trump got us 77% of the way back to where we are now, in just. nine. months.

GDP

From the time he took office until the quarter before the pandemic, GDP growth under President Trump averaged 2.8%. (Under the Obama-Biden administration, it averaged less than 2.2%.) In the first quarter of 2020, which included the normal months of January and (mostly) February, but also the partial shutdown month of March, GDP contracted by 5.5%. In the second quarter, which included the full shutdown month of April (note that some large states like California and New York as well as smaller states like Hawaii and New Mexico remained shut down longer), GDP declined by a record 31.6%.

In the third quarter, with the economy fully open, GDP grew by a record 31%. And in the fourth quarter, it grew by more than 4%.

So President Biden inherited an economy that had already recovered, and was growing at an above-trend pace. And that continued through 2021 (thanks again to Trump - we'll get to that). But by 2022, GDP contracted again, for two consecutive quarters, the textbook definition of a recession (although the administration claimed that the definition had changed). No recession would have occurred under Trump had covid not hit. Yet it took the Biden administration only a year to turn a fully recovered, growing economy into a contracting one.

GDP growth under President Biden has averaged 2.7%, less than under President Trump prior to the covid shutdown (after having inherited the anemic growth of the Obama-Biden era). 2024 Q1 growth was just 1.4%, and Q2 growth is expected to be below 2% again, which will bring the Biden average even lower.

CPI

Now, this is a tricky one. Although President Biden claims he inherited 9% inflation when he took office, he didn't. (For the record, I don't believe he's intentionally lying when he says that. I think he just doesn't have a clue.) He inherited 1.4% inflation, as measured by year-over-year CPI. He created 9% inflation, which was the level of CPI just 15 months after he took office - the highest level since I was in college, and I just qualified for Medicare a few months ago. But let's get back to current inflation in a minute.

The 1.4% inflation that President Biden inherited was attributable largely to the fact that consumption plummeted during the covid shutdown - not so much because people couldn't afford to buy stuff. Sure, those 22 million people whose jobs were destroyed couldn't buy much during the period of time they were out of work. But the jobs came back pretty quickly, and there were trillions of dollars of stimulus payments in the interim.

However, most of the people who lost their jobs were at the "bottom" of the economy. I wrote extensively at the time about how it was a "bottom-up" recession, and predicted - correctly, I might boast - that that was the reason the recovery would be very rapid, and very strong. The people at the "top" of the economy - the highest wage earners - didn't lose their jobs. And many of them received stimulus payments they didn't need, because the income bar the government set for the stimulus payments was set so high.

So those people's incomes weren't affected; in fact, in some cases they were augmented by stimulus - but they still couldn't buy stuff, or travel. Why? Because the stores were closed, the airplanes were grounded, the cruise ships weren't allowed to take passengers, and the hotels were closed, and then re-opened at limited capacity. Some states imposed draconian quarantine requirements - Hawaii even encouraged residents to rat out visitors who violated them, and provided a hotline for them to use, so that the police could round them up. Shades of 1930s Germany or Stalinist Russia.

In any event, when the economy did re-open, and travel resumed, consumption did, also. But remember that CPI is typically measured year-over-year. So consumption in January 2021, when President Biden was inaugurated, was still only up 1.4% over January 2020, when the economy was roaring along under President Trump. In January 2021, cruising was still not allowed, strict quarantine and vaccine requirements were still in place for travel abroad, masks were required on airplanes, some states still had those draconian quarantine requirements in place, and some airlines were still limiting seats - and nearly all airlines had cut routes. There were also lingering supply chain issues that prevented some goods from getting to market.

The point of all of this is that I can't give President Trump too much credit for the low inflation that persisted post-pandemic, when it averaged just 1.1%. So let's look at his record pre-covid: CPI averaged 1.9% during that time. Under President Biden, it's averaged 5.4% - the highest average under any President since Jimmy Carter.

Now, President Biden also likes to say that prices have come down recently. That's also false, and probably just speaks to the fact that he doesn't understand inflation. The rate of inflation has come down, from the 9% peak in June 2022 to the most recent reading of 3.3%. But that still means that prices are up 3.3% vs. a year ago. And that 3.3% increase in prices vs. 2023 is on top of 2023's 4.9% increase, over 2022's 9% increase over 2021 ... get the picture? Prices under Joe Biden are up 20% in total, and his term isn't even over yet (technically). Prices under President Trump only rose 3.9% - and even without the dampening effects of covid, they were only on pace to rise 7.6%.

Interest Rates

As a result of the disastrous policies that led to rampant inflation under President Biden, the Fed has had to tighten interest rates aggressively. (What does this have to do with recovering from covid, you ask? Well, the catalyst for the runaway inflation that was launched in 2021 - and the thing that President Biden claims saved us from covid - was the massive, and wholly unnecessary, stimulus/spending bill he signed immediately after he took office.)

The rate on a 30-year fixed-rate mortgage, as of this writing, is 6.85%, according to Bankrate.com. When President Trump left office, it was 2.65% - a record low. On the average mortgage amount of $330,000, that's a difference in the monthly principal and interest payment of $832 - in other words, your mortgage payment on that median-priced home would have increased by 63%. (And mortgage rates actually peaked at more than 7.8% last October - again, under President Biden.)

Interest rates on everything else are up too, from auto loans to credit cards. And credit card balances are at record levels, because more and more consumers are having to borrow to pay for everyday needs, thanks to prices being 20% higher than they were less than four years ago.

Housing

Finally, let's look at the effect those higher mortgage rates have had on home prices. Home prices in virtually every market in the U.S. have been rising year-over-year, and in many markets, they're at record levels. That's good news if you're a homeowner looking to sell. The problem is that no one can afford to buy.

Prices are rising, because there's no inventory, because no one is selling, because they don't want to buy another home at these mortgage rates. (If you still have a mortgage today, chances are your rate is under 4%.) The only homes being bought are new construction, and new construction is priced on a cost-plus basis.

The most widely-followed national home price index, the S&P/Case-Shiller Index, which tracks 20 major metropolitan markets, is up 7.2% vs. a year ago, and that's unsustainable. Home prices simply shouldn't rise much more than the rate of inflation, since they don't throw off cash flows, unless you're in a market where buildable land is scarce and demand is high. Home prices are up 33% since President Biden took office. And rent inflation is up more than 21% under his presidency, vs. less than 14% under President Trump.

The Vaccine

This one's a little controversial, because many people who support Trump believe the vaccine kills people (which is curious, since Trump is the President responsible for fast-tracking the vaccine and getting it to the market in the first place), while those who oppose him embrace the vaccine - also curious, since the new Democrat nominee (for now), Kamala Harris, once said she wouldn't take the vaccine because it was "Trump's vaccine," and therefore dangerous. But the purpose of this post is not to discuss the merits or conspiracy theories surrounding the vaccine.

President Trump cut through the red tape of the bloated FDA to rush the vaccine into production - remember Operation Warp Speed? Do you think President Biden could have gotten a new vaccine, in response to a previously unheard of virus, into production, approved, to market, and ready for distribution globally in ten months? Heck, he took $7 billion of our money to build 500,000 EV charging stations two years ago, and to date has built twelve. He took another $7 billion to expand internet access to rural areas, and to date ... nothing has happened on that front.

In spite of Vice President Harris' reluctance to take the "Trump Vaccine" in late 2020, immediately after the election she and President Biden rolled up their sleeves and accepted the gift that President Trump made available for them. Then they followed his administration's distribution plan (and even managed to screw that up), and even went so far as to try to mandate the very vaccine that she had urged Americans not to get because it was "Trump's."

Well, she and her boss took credit for it. But it was indeed Trump's vaccine, and he's the one that made it available, which was a big part of the reason for the strength of the recovery in 2021, President Biden's first year in office, because more and more swaths of the economy re-opened on the basis on widespread vaccine availability and adoption.

Conclusion

In summary, Donald Trump - not Joe Biden - engineered the recovery from covid. Let's recap:

• Under President Trump 57% of the jobs destroyed by the shutdown were recovered, with 12.5 million jobs brought back in nine months. It took President Biden three times that long to "add" 12.5 million jobs.
• Under President Trump, unemployment fell eight percentage points from the pandemic peak - again, in nine months. Under President Biden, it's fallen by two percentage points in nearly four years.
• Under President Trump, GDP growth went from -32% to 31% in one quarter, then continued to grow through the end of his term. Total GDP at the end of 2019, the quarter before the pandemic began, was $20.95 trillion. By the time Trump left office, it was about $20.8 trillion. So economic growth had 99% recovered when President Trump left office. A year later, the economy was contracting, and today, GDP growth is less than 1.5%.
• What growth there was in 2021 was due to the widespread availability of the covid vaccine, leading to more and more segments of the economy re-opening. That vaccine was fast-tracked by President Trump.

The only economic contributions that the Biden-Harris team have made on their own have been rampant inflation, soaring interest rates, and unaffordable housing costs.

Do we really want four more years of this - and from the undercard, no less?

Okay, so maybe this was political. But, you know what? It's political to say you inherited 9% inflation, when you didn't inherit it, you created it. It's political to say you brought the economy back from covid when you know you didn't - and it's political for your propaganda mouthpiece, who knows better, to repeat the same lie. And it's political to say that your predecessor did nothing about covid, when his response was swift, effective, and strong - something that can't be said about anything you've done for the last three-plus painful, embarrassing years.

So, you've got to fight fire with fire. You've got to fight lies with the truth. And ...

The numbers never lie.

These Are The Facts, And They Are Undisputed

The title of this post is taken from a line uttered by Kevin Bacon in the excellent film, "A Few Good Men." That film gave us many great lines, and this is just one of them.

The Curmudgeon is back, after a long hiatus. So biased is the national news these days that I can barely stomach watching it. I mostly watch YouTube travel videos and the NFL Network, though the latter is also biased; as a Chiefs fan, I can only say that we got our vindication this season. As safety Justin Reid said, we keep the receipts.

But I wanted to set the record straight with regard to some of the reporting that I have been hearing lately on the rare occasions that I do catch a snippet here and there of the blatant yellow journalism that has supplanted true reporting of the national news. As such, I consider this post more of an economic treatise than a political one, but interpret it as you will.

Recently, the White House and its propaganda arm, the mainstream media, have been touting President Biden's economic record. After all, they can't say much about his record on border security, crime, foreign policy, or pretty much any other policy matter. And, of course, they have to deflect the consistent reporting of the President's glaringly apparent cognitive decline. So they point to some economic success that, quite frankly, leaves me scratching my head. It calls to mind the fable of the Emperor's New Clothes.

Specifically, I've been hearing that President Biden "inherited a pandemic, and has engineered an economic recovery" therefrom.

Well, let me set the record straight; as as is my custom, I'll do it with data.

Let's start with the undisputable fact that the covid pandemic hit the United States, and the rest of the world, in March of 2020. At that time, Donald Trump was President of the United States, not Joe Biden. Thus President Trump, not President Biden, "inherited" the covid pandemic. (I won't editorialize on that pandemic's origins, or how it coincided with President Trump's re-election bid in 2020. Read between the lines as you will.)

To begin with, let's look at job growth. President Trump took office in January 2017. Nonfarm payrolls grew by an average of 180k from February 2017 to February 2020, the month before covid hit. That's a pretty healthy rate of growth.

Now, I'll concede that Trump stood by and let Fauci, Birx, et al convince most of the U.S. governors to shut down the nation's economy in response to the pandemic, which I maintain will eventually be viewed as the single worst decision ever made by policymakers in global history. That was the single worst policy decision of Trump's presidency. As a result, in just six weeks, more than 22 million jobs were eliminated in the U.S. alone, a staggering number that was unprecedented in economic history. 

President Trump was widely ridiculed for predicting that, in the aftermath of the shutdown, the U.S. economy would experience a "super-V-shaped recovery." Yet that's exactly what happened. As I've written before, the recession caused by the shutdown was unprecedented in that it was bottom-up, vs. the top-down recessions that have been typical throughout history. As such, demand remained extant.

The vast majority of Americans did not lose their jobs, and those that did not represented the highest earning levels of the economic spectrum. They still had demand for travel, dining out, shopping, and all the things they normally did when the economy was open and functioning. So when it re-opened in May of 2020 (in most states), they resumed consumption - with a vengeance, because they'd saved their largely intact incomes for two months of interrupted consumption; indeed, bolstered by government stimulus they didn't really need.

As a result, those jobs that were eliminated in the bottom echelons of the economy came roaring back. Nonfarm payroll growth from May 2020 through January 2021, when President Trump left office, totaled 12.5 million jobs, an average of 1.4 million jobs per month, which was also unprecedented in U.S. history. In other words, more than half the jobs eliminated were recovered in the nine remaining months of President Trump's tenure. It took another 17 months under President Biden to recover the remaining jobs eliminated by the shutdown. Thus President Trump did the yeoman's work of the job recovery.

Now, payroll growth under Trump following the shutdown wasn't job creation, it was job recovery - just as the job "creation" under the Biden administration has been job recovery, and we have yet to reach equilibrium in terms of recovering all the jobs that were destroyed in the shutdown plus the jobs that would have been created through normal growth had the economy never been shut down to begin with. In fact, we remain about 4 million jobs short of that equilibrium point. Such are the long-term implications of that disastrous decision to shut down the economy. Still, the point remains: job recovery in the months under Trump eclipsed those under Biden on a per-month basis.

Now, let's look at the unemployment rate. When President Trump took office in January 2017, it was 4.7%. In February 2020, before covid hit, it was down to 3.5%, about where it is now. Unemployment among nearly all minority categories was at record lows, below today's levels. In April 2020, after two months of shutting down the economy, unemployment had risen to a record 14.8%. But by January 2021, when President Trump left office, the unemployment rate was back down to 6.4%.

Are you beginning to see the picture? President Trump inherited a pandemic. Then he engineered a recovery, which his successor inherited.

Let's turn our attention to inflation, using the broad Consumer Price Index (CPI) as our measure. In January 2017, when President Trump took office, CPI year-over-year was 2.5%. By September 2019, it was down to 1.7%. When President Trump left office in January 2021, it was just 1.4%, but that was aided by the pandemic, which suppressed consumption and disrupted the supply chain.

Since that time, inflation has averaged about 6%. It's currently just over 3%, but it peaked at more than 9% under President Biden. And we have to consider the cumulative effect of today's 3% inflation rate on top of last year's 9% inflation rate. That means prices on many items are up by double digits vs. two years ago. I won't even compare what a loaf of bread, a gallon of milk, a dozen eggs, or a restaurant meal cost today to what they cost in January 2017. But I will note that a gallon of gas cost $2.30 in January 2017; $2.10 in November 2020; and is currently about $3.30.

Now, let's talk about GDP growth, the overall measure of economic output. Under President Obama, it averaged 2.2%, which is pretty anemic. Under President Trump pre-covid, it averaged 2.8%, which is quite a bit healthier. During the first two quarters of 2020 - the pandemic quarters - it averaged -18.5%, which was a record low. In fact, in the second quarter of 2020, it was an overwhelming record of -31.6%, again the result of the disastrous decision to shut down the economy.

However, in the third quarter of 2020, it was another record: +31%, nearly recovering the entire lost output of the prior quarter. The average growth rate from 2020 Q3 to 2021 Q1, when President Trump left office, was also a record, 13.4%. There's that "super-V-shaped recovery" we were promised. The average under President Biden has been about 2.8% - a healthy number, but still aided by the recovery from the pandemic (and also aided by things like people spending money on travel and consumption instead of repaying their student loan obligations, as loan delinquencies have risen precipitously). And still just back to where President Trump had gotten economic growth, so hardly a "recovery."

Next, let's examine the stock market, something the Biden administration has really been touting, because stocks have been trading at record levels. (When Trump was President, we were told by the media that stock market performance wasn't an indicator of economic health; now, it apparently is.)

Remember the dire warnings of what would happen to stocks if Trump was elected in 2016? We were told that the market would tank.

Indeed, after the election results came in late in the evening on Election Day in November 2016, stock futures sold off dramatically. Then, they began to rally. And when the market opened the next day, stocks rallied even more. As I recall, the total swing in the market from the low in stock futures overnight to the close on the day after Election Day was something like 1,300 points on the Dow, which was unprecedented.

On November 4, 2016, the S&P 500 closed at 2085. By November 9, just after the election, the index was up to 2163, a gain of nearly 4% in just five days. By February 20, 2020, just before the pandemic hit, the S&P was up to 3373, a gain of nearly 62% over when President Trump took office.

Then, after the covid shutdown, the index plunged by more than 33% to 2237 by March 23, 2020. However, by Election Day, 2020, it was 3369, up more than 50% from the pandemic low, and nearly back to the pre-pandemic high, in just eight months. Overall, it was still up about 62% from when President Trump was elected, in spite of the pandemic.

Today, it's about 5089, up about 51% from the Election Day 2020 level. Some of that is due to the continued recovery from the pandemic, a recovery that President Biden inherited. Many market observers also attribute the stock market's performance to speculation regarding the 2024 election. President Biden's poll numbers are at record lows, and President Trump is the presumptive nominee for the GOP. Given his track record during his term, the market is optimistic over the prospect of a second term. Of course, some of it is attributable to fundamentals that have nothing to do with who's in the White House: corporate earnings, interest rates possibly declining, the performance of tech stocks given the euphoria over AI, etc.

Finally, let's consider one more thing, and this one may be controversial among some of my readers: the covid vaccine. I decided some time ago not to weigh in on the various theories surrounding the vaccines. I'm not an expert in such matters (and, if you're reading this, neither are you). I only know that numbers don't lie. And I know that the economy would never have fully re-opened without the vaccines being rolled out. Beyond that, people are going to believe what they're pre-disposed to believe, and no amount of data will dissuade them. If you want to believe the world is flat, or that the lunar landing was a hoax, that's your prerogative. Suffice it to say that I've received the original vaccine and two boosters, and my heart is as healthy as it's ever been, and I have yet to develop a craving for bananas.

The CDC and the FDA are two of the most bloated and lethargic government agencies in the U.S., and that's saying something, given the slow-moving bureaucracy that is entrenched in our nation's capital. But under President Trump, those agencies fast-tracked the vaccine rollout in a way that has never been witnessed. Between April 2020 and January 2021, the vaccines were developed and made ready to distribute not just nationally, but globally, and a plan was in place to deploy them.

President Biden inherited that plan, and all he had to do was implement it. In fact, he inherited not a pandemic, as his administration claims, but a robust recovery, as the numbers above prove. He has ridden the wave of that recovery, in some instances letting it ride to new highs, as with the stock market, or nonfarm payrolls. In other instances, such as energy or overall price levels, he has placed roadblocks that have impeded progress, and even reversed the recovery that was in place prior to his presidency.

One thing is clear, however: President Biden did not inherit a pandemic. President Trump did. And President Biden has not engineered a recovery. The recovery was well underway before he took office, and he inherited that recovery.

These are the facts, and they are undisputed.

Bonds, the Yield Curve, and Recession Indicators - Part III: What the Yield Curve Tells Us About the Economy

Okay, we've covered the bond market (https://theeconomiccurmudgeon.blogspot.com/2023/05/bonds-yield-curve-and-recession.html), and we've introduced the yield curve - what determines it, what it normally looks like, how it can change, and what it generally means when it's inverted (https://theeconomiccurmudgeon.blogspot.com/2023/05/bonds-yield-curve-and-recession_9.html). Now it's time to take a deeper dive into the yield curve as an indicator of economic turning points. We'll also talk about at least one other indicator of economic downturns. But first, let's review some yield curve basics.

Below is an illustration of a normal, upward-sloping yield curve:

Next, let's review what an inverted yield curve looks like:

Finally, let's review the spread between the ten-year Treasury yield and the two-year Treasury yield, which illustrates the inversion of the yield curve (when the spread is negative - i.e., when the two-year yield is higher than the ten-year yield - the curve is inverted):

To recap, the normal yield curve is upward-sloping because we generally expect the economy to grow over the long run, so the expectations theory tells us that the Fed will be raising rates over the long run to rein in inflation. Thus, under normal conditions, and when the economy is growing (and is expected to continue to grow), the yield curve will generally be upward-sloping, with long yields higher than short yields.

It's important for us to to address why we consider this normal. The third graph above answers that question. From that graph, you can see that the yield curve is normally (most often) upward-sloping - the ten-year yield normally exceeds the two-year yield. The graph shows that the curve has only been inverted for relatively short periods of time, and those periods have been relatively few and far between.

For example, we see from the graph that the curve was inverted from the late 1970s through the early 1980s, with a couple of brief periods where the spread between the ten-year and the two-year turned positive, only to invert and become negative again. Then, the spread was positive until the late 1980s, at which point it became negative again, for a period of a couple of years. By about 1990, it was positive again, and it remained so, with the exception of a brief dip in the late 1990s, until about 2000, when the curve again inverted for a short period. The spread was positive from about 2001 until the mid-2000s, when the curve inverted once more, for about two years, again with a brief correction. After 2007, the spread was positive until 2022 (other than a very brief dip into negative territory in 2019, but only for two days, and only by 3-4 basis points).

This is intuitive. Remember that we said that an inverted yield curve has preceded nearly every U.S. recession? Well, as illustrated by the shaded bars in the third graph above, which represent recessions, there have been only six recessions in the last 47 years. (There's actually one recession shown on the graph that was an anomaly; we'll discuss it later.) Those recessions lasted, on average, less than ten months each. So for 60 out of the last 560 or so months (less than 11% of the time), we've been in recession. The rest of the time, we haven't been. So we'd say that recessions aren't the norm, and thus the normal state of the economy is growth. That supports the expectation that the economy is going to grow over the long run, and thus that future Fed moves will be to raise rates, which would make an upward-sloping yield curve the norm, according to the expectations theory.

Another critical point to make is that there has to be some reason that an inverted yield curve signals a future recession. Otherwise, it's merely a coincidence. For example, you've probably heard it said that since the 1929 stock market crash that precipitated the Great Depression, a recession has occurred, on average, every seven years. This has led some people to conclude that, when we're about six years past the last recession, "we're due for another one."

That's simply not the case. Recessions aren't like phases of the moon or solar eclipses; they're not tied to the calendar. The fact that one has occurred, on average, every seven years, is mere coincidence. The time between recessions, since the Great Depression, has varied as follows (I'm rounding to whole years):

• Four years
• Seven years
• Three years
• Three years
• Three years
• Two years
• Nine years
• Three years
• Five years
• One year
• Eight years
• Ten years
• Six years
• Eleven years

That averages to seven years, but as you can see, the variance is wide - from one year to eleven years. There's nothing to indicate that once the economy has grown for six years, a recession is "due," nor is there anything to suggest that the economy will grow for seven years without a recession occurring. The seven-year average is coincidental.

There are similar coincidences in the stock market. It used to hold true that if the Super Bowl winner was an NFC or original NFL team, the market would be up for the year, and if the winner was an AFC or original AFL team, the market would be down. Obviously, the winner of the Super Bowl doesn't determine the performance of the stock market; it was merely a coincidence. And it eventually broke down.

See, something has to cause a recession. It doesn't just happen. And that's a critical point in our discussion in this post.

So how does that relate to an inverted yield curve being a leading indicator of a recession? Is that mere coincidence as well?

No, it is not. In our last post, we established that the yield curve inverts because investors and traders at the long end begin to see signs of emerging economic weakness - they see signs of a recession on the horizon. And they believe that the Fed is going to start cutting rates (easing) in response to that weakness, such that in the long-term (relatively speaking), rates will be lower. So they bid yields at the long end of the curve lower to reflect those expectations, even though the Fed may still be raising rates, because the recession isn't here yet, and the economy is still growing. (And remember, we said that the Fed has a tendency to overshoot monetary policy, so it may continue tightening longer than it should.)

So there's a very good reason why the yield curve inverts prior to a recession: there are fundamental signs that a recession is coming, and traders see those signs on the horizon, and start to bid down yields at the long end of the curve accordingly.

The third graph above shows that the yield curve inverted prior to every recession since the recession of 1980. (I'm not counting the 2020 recession, nor the 2019 "inversion." I'll explain why shortly.) This validates the reliability of the inverted yield curve as a leading indicator of recessions. And it makes sense, for the reasons noted above. Bond traders and investors are pretty smart, and they watch economic data closely. So they're pretty good at seeing signs of economic weakness, and they respond to them with their trades.

Now, let's take a brief detour. Why don't I count the recession of 2020? Because it wasn't caused by any of the fundamental economic factors we normally associate with a recession. The economy in 2019 was very strong. Unemployment was at historic lows. Every economic indicator showed strength. Nobody in their right mind predicted a recession.

Then, the covid pandemic hit. And the government took the unprecedented and previously unimaginable step of shutting down the U.S. economy, causing the loss of 22 million jobs in just six weeks. Want to know what that looks like? Check out this graph of non-farm payrolls:

Look at the magnitude of the drop in 2020. It's massive.

This was a bottom-up recession, as I discussed in this blog at the time. That's never happened before; recessions tend to be top-down, with jobs at the top of the economy (i.e., the highest earners) being lost first, and that trickles down to lower-paying service sector and retail jobs. The covid shutdown eliminated the service sector and retail jobs - retail stores, hotels, restaurants, etc. Earners at the higher end of the pay spectrum kept their jobs, for the most part. (That's the primary reason the recovery was so rapid.)

So I discount the 2020 recession because it was an anomaly. Unlike every other recession, which have been naturally occurring, the 2020 recession was manufactured - it was forced upon us, by the government shutting down the economy, not by the economy encountering fundamental weakness and contracting.

Likewise, I discount the "inversion" that occurred in 2019 because that, too, was an anomaly. Again, nobody anticipated the 2020 recession. Nobody saw covid coming (except maybe Anthony Fauci, and he's not smart enough to be a bond trader). Also, as noted above, the two-year yield only exceeded the ten-year yield for two days in September 2019, and by only 3-4 basis points. It was more of a flattening of the yield curve than a true inversion. It happened because the bond market began to speculate that the Fed had once more overdone a series of rate hikes between 2016 and 2019, which sparked fears that higher interest rates could potentially slow the economy.

Those fears proved to be unfounded; jobs grew by about a million in the five months from September 2019 to February 2020, and every other economic indicator was strongly positive. You can see from the 10-year/2-year spread graph how quickly the bond market realized the fallacy of its fears. (Also, the Fed began cutting rates about three weeks before the 10-year yield dipped below the 2-year yield, helping to allay fears that the Fed was going to choke off growth, and Fed officials were signaling that there were more rate cuts to come.)

Okay, so we've established that recessions happen for a reason (except for the 2020 recession - well, it happened for a reason, but not a naturally-occurring one), and that there's a good reason that an inverted yield curve is a leading indicator of a recession, based on bond market expectations. So what's all this about a false notion about the yield curve as an indicator of recessions?

There is a theory - actually, it's more of a notion, and really it's a misconception - that while an inverted curve does precede a recession, it's not a great indicator of an imminent recession, because the curve often inverts well before recession ensues. That's true. For example, the curve inverted 17 months before the 1980 recession; 19 months before the 1990 recession; 13 months before the 2001 recession; and 16 months before the 2007 recession (it briefly inverted before that, then corrected before inverting again). But some investors try to time the market (with little success), so they want to know exactly when a recession is going to start. Just knowing a recession is coming isn't good enough for them.

So in an effort to meet that need, proponents of this notion argue that a better indicator of an imminent recession is the "uninversion" of the yield curve. Again looking at our graph of the 10-year/2-year spread, they argue that the yield curve "uninverted" prior to the recessions in 1990, 2001, and 2007. They also use the flattening of the curve in 2019 as an example of an inversion, and claim that the curve subsequently "uninverted" before the 2020 recession. These "uninversions," they argue, occurred just three months before the 1990 recession; two months before the 2001 recession; six months before the 2007 recession; and five months before the 2020 recession. On the basis of their observations of those four recessions, they claim that the yield curve has "uninverted" just prior to every recession.

Let's unpack this notion. First, who are the people who promote this idea? They're not economists; I haven't seen or heard one economist put forth this idea. And they're certainly not in the bond business. I spent four years trading, managing and hedging bonds on the buy side, and 21 years on a bond desk as an investment advisor, running an advisory desk, as an economist, and as CEO of a bond sales and advisory firm, and I never once encountered this notion.

In fact, not once in those 25 years did I ever come across the term "uninversion." When the yield curve is no longer inverted, we don't say that it "uninverted." At least no one who knows anything about the bond market uses that term. Since the normal state of the curve is upward-sloping, when the curve returns to that shape, we say that it "reverts" to normal, just as in statistics we say that after a certain data series undergoes an anomalous period, it reverts to the mean, or to its normal state.

For example, the pace of home price appreciation in a given market is mean-reverting. When something happens that results in the pace of home price appreciation exceeding the long-term mean in a given market - like historically low interest rates - there will inevitably be a correction. That happened after the early 2000s, when then-record low mortgage rates resulted in rapid home price appreciation that resulted in a historic housing bubble, which burst in 2007, resulting in a massive correction before home price appreciation reverted to the mean. It happened again in 2021 and 2022, when again record low mortgage rates fueled a home price bubble, which is now correcting as price appreciation is reverting to the mean.

So any knowledgeable economist or bond trader or investor would say that an inverted curve reverts to normal. As far as I can observe, the people that use the term "uninversion" and promote this theory fall into four camps: 1) some fringe equity fund managers and equity-centric investment advisors who don't understand the bond market; 2) people who write those far-out investment blogs that promote conspiracy-esque theories like the GameStop and AMC stock aficionados; 3) business journalists (and I believe I've already established how knowledgeable they are); and 4) people on social media who follow those in the first three camps, and don't know anything about the bond market or the yield curve, but want to sound like they know something the rest of you don't know.

Okay, so back to their "theory." It kind of looks like it's valid. Is it?

Well, first, note that they conveniently ignore the 1980 recession, which began while the curve was still inverted. Likewise, they ignore the 1981 recession, which also began while the curve was still inverted. Now, if they were smart, they'd try to argue that those recessions occurred before the monetarist era was really underway. Only a) that's a disconnect; it would have nothing to do with why those recessions ensued while the curve was still inverted, and b) it would be incorrect, because the monetarist era began in 1979, and c) they don't know what the monetarist era is, which is probably why they don't attempt to make that argument. In any event, by excluding those recessions, their claim that every recession has been preceded by an "uninversion" falls flat.

The fact of the matter is, they exclude those recessions because they don't fit their pattern.

They also include the 2020 recession, and the 2019 flattening as an "inversion." But the curve didn't meaningfully invert, nor can we argue that it reverted to normal, in 2019, and again, nobody could have seen the 2020 recession coming, so that doesn't hold water. They only include those anomalies because, again, including them supports their pattern.

Also, they've been arguing recently that the curve is once again on the precipice of "uninverting." Every time there's a move in bond yields that results in the curve becoming less inverted (i.e., the spread between the 2-year and 10-year yields narrowing), they claim that "uninversion" is just around the corner, and that when that happens, a recession is imminent. In other words, they tend to be doomsayers. And I'll comment on doomsayers in a few minutes.

The problem with the claim that the inverted yield curve is about to become "uninverted" is that it simply isn't true. The curve is currently inverted by about 47bp. In early March, before the failure of Silicon Valley Bank and Signature Bank, it was inverted by nearly 90bp. But the panic over those bank failures led to a flight to quality, which led to a flurry of bond-buying that resulted in lower yields on the two-year relative to the ten-year, and that resulted in the spread between the two narrowing. However, the curve has been inverted by at least 40bp since last October, and the inversion has averaged about 50bp for the two months since those bank failures. It would take a massive move in Treasuries for the curve to no longer be inverted. And the people who push this notion are the same people who argue that large moves in Treasury yields rarely happen, so they contradict themselves.

(I should also note that these same doomsayers claimed that those bank failures signaled a systemic banking crisis in the U.S.)

The thing about doomsayers is this: if they make their claims long enough, eventually they may turn out to be true. In other words, if they keep saying a recession is imminent, eventually, there will be a recession. Then, they'll say, "See? I told you so."

Just as there has to be a reason that the curve inverts before a recession, there would have to be a reason that it reverts to normal (or "uninverts," in the lexicon of the uninformed) immediately before a recession, for that to be a reliable indicator. And the proponents of this "theory" can't point you to one.

Well, I can tell you why the curve reverted to normal prior to the recessions in 1990, 2001, and 2007:

The Fed had already begun easing before those recessions began.

In June 1989, the Fed began cutting the Fed funds target, after having raised it by about 400bp over the previous two years. By the time the 1990 recession began, they had cut the funds target by more than 150bp. However, it wasn't enough, and the recession hit in July 1990 (largely brought on by the S&L crisis of the 1980s).

In January 2001, the Fed cut the funds target by a whopping 100bp in one move (they normally move 25bp at a time), but that wasn't enough either; the recession began in March, as a result of the dot-com bubble bursting. And in September 2007, they again cut the target rate by a larger-than-normal 50bp, and continued easing, but it once again was insufficient to prevent the recession that began in December, which resulted from the housing crisis.

In all three of those cases, as soon as the Fed began easing, or signaled that it would, bond traders began bidding up long-term yields, and bidding down short-term yields, and the curve reverted to normal.

And the reason the recessions of 1980 and 1981 began while the curve was still inverted is because the Fed was still increasing rates at that time. Volcker raised the funds target from an average of just over 11% in 1979 to 20% in June 1981. The 1980 recession began in January, and the 1981 recession began in July. Those recessions happened largely because the Fed raised short-term rates so high.

So the yield curve reverts to normal when the Fed begins easing, not when a recession is imminent. It may be a coincidence that the Fed begins easing when a recession is imminent, if their timing is right. But a better indicator that a recession is imminent is that the Fed begins easing, not that the yield curve "uninverts." That's just coincidental poppycock.

The yield curve will not revert to normal because of movements in bond yields per se. Recent large movements have been primarily due to irrational fears over the banking sector's health. For example, on March 13, there was a sizeable move in bond yields that brought these "uninversion" proponents out of the woodwork and had them proclaiming that the curve was "uninverting" rapidly, and thus recession was nigh. Guess what precipitated that move in bonds on March 13?

Signature Bank failed on March 12, two days after Silicon Valley Bank failed.

The yield curve will revert to normal when and if the Fed begins easing, and then you can bet a recession will be just around the corner - not because the yield curve reverted to normal, or because the Fed started easing, but because of economic weakness that has been emerging for quite some time, as the bond market has seen coming since the curve inverted last July. The Fed will begin easing because of that weakness, not vice-versa.

Now, one last mythical notion that I've recently seen regarding recessionary signals. Some of these same folks have claimed that "unemployment is a lagging indicator, because it tends to peak after a recession has ended."

Well, the second part of that statement is true. The unemployment rate peaked after the end of nearly every U.S. recession since WWII (the peak in unemployment coincided with the ends of the 1948-49 recession and the 1980 recession, and I'm not counting the 2020 recession, though the peak coincided with the end of that anomaly, too). However, the graph below shows that an increasing jobless rate was a leading indicator of the recessions that began in 1948, 1953 (barely), 1957, 1960, 1973 (again, barely), 1980, 1990 (barely again), 2001, and 2007 (and I'm not counting 2020, because the economic shutdown was what caused unemployment to skyrocket that year). It was a coincident indicator of the recessions that began in 1969 and 1981, and if you want to say it was a coincident indicator of the recessions that started in 1953, 1973, and 1990, I'm okay with that, too.

Anyone who understands economics knows that for an indicator to be leading, concurrent, or lagging, we don't look at when it peaks, we look at when it signals a turning point. In other words, you look at the leading edge, not the trailing edge. And the graph above clearly shows that the unemployment rate has never been a lagging indicator.

Now, we've established that the yield curve is signaling a recession. However, the unemployment rate just fell from 3.5% in March to 3.4% in April. So can a recession really be on the horizon, if the labor market is strong?

This is why I've always looked at "the numbers behind the numbers." Consider these other facts about the labor market:

• The only reason the unemployment rate declined in April was because the labor force declined. Besides normal retirement, people typically exit the labor force for one of two reasons: their employers incent them to, or they become discouraged with their prospects for employment. In the former case, companies incent people to leave the labor force in order to trim their payrolls, in advance of outright layoffs. In the latter case, it means people are having trouble finding suitable jobs that match their skills.
• Non-farm payroll growth is decelerating, and the February and March numbers were revised lower.
• Job openings have declined by about 2.5 million over the last year. That's equal to the decline experienced when the government shut down the economy in response to the pandemic; it just took longer. The last two job openings reports have been significant downside surprises.
• Temporary jobs have declined for three consecutive months. Companies tend to cut temp jobs first, before laying off permanent workers.
• The average workweek has declined steadily since the beginning of 2021. Besides cutting temp jobs, companies cut overtime in advance of cutting jobs outright.

So there are definitely cracks in the labor market. (These are just some of the signs that the bond market was seeing back in July of 2022, when the yield curve began to invert.) And we're not in recession yet. Thus labor is very much a leading indicator of recessions.

For anyone who's suffered through all three of these posts, kudos. I hope it's been informative, and educational. And I hope it's dispelled any myths you may have seen floating around about what is and is not an indicator of an imminent recession. Remember, there has to be a reason that something is a recessionary signal; otherwise, it's just a coincidence, like which conference's team won the Super Bowl.

Bonds, the Yield Curve, and Recession Indicators - Part II: the Yield Curve

Now that we're armed with a basic understanding of bonds and the various Treasury debt maturities, let's talk about the yield curve. (In case you missed the primer on bonds, it's here: https://theeconomiccurmudgeon.blogspot.com/2023/05/bonds-yield-curve-and-recession.html) First, let's recap the Treasury maturities:

• 1-month Treasury bill, or T-bill
• 3-month T-bill
• 6-month T-bill
• 1-year T-bill
• 2-year Treasury note
• 3-year note
• 5-year note
• 10-year note
• 20-year bond
• 30-year bond

(As a reminder, we'll be using the word "bond" to describe both notes and bonds, as all of these instruments make up the bond market, but technically, the 2-10 year instruments are called notes.)

If we were to graph the yields on those maturities, with time to maturity on the horizontal, or x, axis, and yield on the vertical, or y axis, we'd have a picture of what we call the yield curve. Since the intervals between the times to maturity aren't uniform (e.g., there's only a two-month gap between one and three months, but there's a 10-year gap between 20 and 30 years), the graph is typically represented with the points in between those maturities interpolated step-wise, to illustrate what the yields would be on, say, an outstanding bond with a remaining maturity of 14 years. Don't get hung up on that point; just look at the illustration below.

Since yields change daily (actually, they change throughout the trading day), any graph of the yield curve will be as of a specific point in time. Here's a graph of the Treasury yield curve using closing yields (as of the end of the trading day) on April 1, 2021:

Note that the lowest yield on the curve is the yield on the one-month T-bill, and the highest yield is the yield on the 30-year bond. This is typically the case: short-term yields are generally lower than long-term yields. (We'll discuss why momentarily.) This is what we'd call a "normal" yield curve - it's upward-sloping, left to right, or short-term to long-term.

So why are short-term yields lower than long-term yields? This is referred to as "the term structure of interest rates," or "the term structure of yields." There are three theories that explain the term structure. They're all valid; each plays a role. Let's address them in turn. (Note to my finance geek friends: I realize that the term structure generally refers to the spot and forward curves, rather than the coupon curve; I'm over-simplifying here for the lay reader. I'm not going to get into spot, forward, or swap curves.)

Liquidity Preference Theory

This theory is perhaps the most intuitive. If you have a regular savings account, you can withdraw your money at any time, without penalty. If you want to withdraw funds from your savings account tomorrow, you can do so; if you want to park it there indefinitely, you can do that, too. If you need the money seven weeks from now, you just withdraw the money from your account.

On the other hand, if you have a certificate of deposit (CD), it has a fixed maturity date, like a bond. (As with bonds, there are structured CDs, like callable CDs, but we won't get into that.) If you leave the money deposited in the CD until that maturity date, you'll earn the stated interest rate. But if you try to withdraw it early, you'll pay a penalty, effectively reducing your interest.

Now, why on earth would you tie up your money, let's say for a year, in a CD, when you could just deposit it in a regular savings account and have access to it whenever you want?

If your answer is that you'd earn a higher rate of interest for putting the money in the CD, go to the head of the class - that's the full-credit answer. And you'd expect a higher rate on a five-year CD than on a one-year CD, right? Because you wouldn't have access to the money for five years, vs. being able to withdraw it in a year. The reason you might prefer the one-year CD is that you're not sure whether you'll need the money a year from now, and you're not confident you won't need it for the next five years.

(Another reason might be that you're not sure what rates will be a year from now, and you don't want to tie up your money for five years in case rates are higher in a year, at which time you could take the funds from the maturing one-year CD and deposit them in an account earning even higher interest, but that gets into another theory of the term structure.)

According to bankrate.com, current rates on regular savings accounts range from as low as 0.01% to more than 4.00% for some online banks, but most local brick-and-mortar institutions are going to offer less than 1% currently on regular savings accounts.

One-year CD rates, again per bankrate.com, currently range from 4.75% to 5.10%. This validates the concept that the bank will pay you a higher rate of interest to let them use your money for a full year, without the risk that you'll withdraw it unexpectedly, than they'll pay you for money that you can withdraw at your discretion.

The same concept applies to the term structure of interest rates. The theory is that investors prefer liquidity, meaning they'd rather have access to their funds sooner than later. Except instead of "lending" money to a bank, the investor is "lending" money to the U.S. Treasury. So under normal conditions, we as investors expect a higher rate of interest if we're buying a 2-year Treasury note than if we bought a 3-month T-bill; in the former instance, we don't get our principal back for two years, while in the latter, we have access to our funds in three months. (We could sell the 2-year note in three months, but it might be worth less than par, depending on market yields and thus bond prices in three months - the only way we can be certain we're going to get par at redemption is to hold the note to maturity.)

Likewise, we expect a higher rate of interest on a 5-year note than on a 2-year note; an even higher rate on a 10-year note; and even higher rates on a 20-year or 30-year bond, respectively. Thus, the lowest rates will be paid on those Treasury instruments with the shortest maturities (providing us with the greatest liquidity), and the highest rates will be paid on the longest (least liquid) maturities. We're talking about liquidity here in terms of return of par value at maturity, not how easy it is to sell Treasuries. Also, note that this is a theory; it's generally true, under normal conditions, and that's why a "normal" yield curve is upward-sloping.

In summary, investors have a preference for liquidity, and are willing to accept lower yields for greater liquidity (shorter maturities), but expect higher yields for less liquidity (longer maturities). That preference plays a role in determining the term structure of interest rates.

Market Segmentation Theory

If you have a basic understanding of economics, you know that the laws of supply and demand are immutable. And the greater the demand for something, the higher the price is likely to be. (Technically, I should say the greater the quantity demanded, but let's not get technical. I'm just making the distinction in case there are any budding economists reading this.)

And, as we've established, the higher the price of a bond, the lower its yield. So, the greater the quantity demanded of a given maturity, the lower the yield is likely to be, because the price will increase as the quantity demanded goes up. (Again, this is under normal conditions.) And the less the quantity demanded of a given maturity, the higher the yield is likely to be, because lower demand puts less upward pressure on prices. Looking at that last point another way, if there's less demand for a given maturity, the issuer may have to pay a higher rate of interest to get investors to purchase bonds of that maturity.

Short-term Treasury bills are used by corporations as cash management instruments. There are thousands of U.S. corporations. (Global companies buy U.S. Treasuries, too.) And many of those corporations are massive: the largest U.S. company by market capitalization is Apple, with more than $2.7 trillion in market cap. (Market cap is the value of a company's stock price times the number of shares outstanding.) So if you add up all the companies in the U.S. (actually, the world), and consider the fact that they all have demand for short-term T-bills, it's pretty easy to figure out that the demand for T-bills is going to be massive. Thus, the yield on T-bills is going to be low.

Banks and credit unions tend to invest in Treasury notes, generally in the two- to five-year maturity range. As noted in a previous post, there are more than 4,000 banks in the U.S. and about the same number of credit unions. The total assets of all those institutions combined is about $25 trillion. So there's a lot of demand for medium-term T-notes as well, but not as much as for T-bills. So the yield on those notes is going to be higher than the yield on T-bills.

(Certain insurance companies, like property insurers, also invest in intermediate term notes. Those companies account for about another trillion dollars in size. Also, a number of corporations invest in intermediate maturities as well.)

Life insurance companies generally invest in long-term bonds, because their liabilities are long-term. (A life insurance company's liabilities are the policy amounts they have to pay out when a policyholder dies, so in the case of your life insurance company, you'd better hope their liabilities are long-term.) There are less than 750 life insurance companies in the U.S. The face amount of total life insurance in force is about $20 trillion.

The market segmentation theory holds that there's much greater demand for short-term T-bills, not because of liquidity preference but because of the types of investors that buy them. There's less demand for medium-term notes, and there's even less demand for long-term bonds. Thus, since the highest demand => the highest price => the lowest yield, and so on, yields on T-bills will be lowest, yields on medium-term notes will be higher, and yields on long-term bonds will be the highest, because there are fewer investors in that segment.

(Sidebar: in case you're curious about why banks and property insurers buy medium-term notes, it's similar to the reason that life insurance companies buy long-term bonds: they're matching the average maturity of their liabilities.)

Expectations Theory

The expectations theory is the biggest driver of the term structure of interest rates. It holds that long-term rates are based on expectations of where short-term rates will be in the future. (Note: just as I'm using the terms "bonds" and "notes" somewhat interchangeably, I'm doing the same with "rates" and "yields." My finance geek friends are no doubt grinding their teeth at this; however, if they'd ever worked on a bond trading desk, they'd hear those terms interchanged pretty regularly.)

Let's explain why this is true. Let's say I'm considering buying a ten-year bond. I should be indifferent between buying the ten-year T-note, or buying a one-year T-bill and rolling it over at maturity nine times, for ten years in total. Otherwise, I could execute an arbitrage trade (don't get hung up on that term; it basically just means taking advantage of market inefficiencies). If I'm better off buying the ten-year than rolling the one-year, I could buy the ten-year, sell the one-year short and roll that trade, and pocket the profit. If I'm better off buying and rolling the one-year, I could do the converse. Since we assume that the bond market is efficient and such arbitrage opportunities don't generally exist, we make the assumption that investors are indifferent between buying the ten-year, and buying and rolling the one-year.

If that's the case, then the ten-year yield represents investors' expectations of the one-year yield, ten years forward. It's a similar case for the 30-year yield: it represents expectations of the one-year yield, 30 years forward; the five-year yield represents expectations of the one-year yield five years forward; etc.

This explains why a "normal" yield curve is generally upward-sloping. Investors generally expect that short-term rates will be higher in the future. Why is this?

In answering that question, we're going to start veering away from the theories behind the term structure (though the expectations theory will remain a part of the discussion), and get into Fed policy, economic cycles, and how the yield curve changes in response.

Investors generally assume that over the long run, the economy is going to grow. Sure, there will be downturns, but the long-term trend is expected to generally be upward.

Also, short-term rates are generally controlled by the Federal Open Market Committee (FOMC) of the Federal Reserve. (Instead of that cumbersome reference, I'm just going to use the term, "the Fed.") I'm going to explain in some detail how they do that, but I'm not going to give it a comprehensive treatment; the Fed has a number of policy arrows in its quiver that it can use to achieve its objectives.

The Fed is responsible for two key policy mandates: controlling inflation, and maintaining full employment. To some extent, these mandates are at cross-purposes. Inflation generally occurs when the economy is growing too fast. Prices are rising due to increasing demand that results from people being flush with cash to spend; wages are increasing because companies are expanding and hiring more people; etc. And all that demand for goods, services, and labor is driving up costs and prices.

On the flip side, stable employment is threatened when the economy is contracting. Companies cut jobs as they anticipate weaker economic conditions. As they forecast lower sales (i.e., less demand for goods and services), they start to trim payrolls, beginning by cutting hours and temporary help, and then by cutting jobs outright.

So the Fed has to walk a tightrope between stimulating the economy such that employment doesn't fall significantly, but not stimulating it so much that growth becomes so strong that inflation results. How does it do that?

Prior to the 1980s, the Fed manipulated the money supply to achieve its policy objectives. It pumped more money into the economy when it wanted to stimulate it, and it withdrew money from the economy when it wanted to slow it down. Pretty simple.

Then, in 1980, three things happened. President Carter had just appointed a hard-nosed economist named Paul Volcker as Chairman of the Fed in 1979. At the same time, inflation had been rampant throughout the 1970s, averaging more than 7% per year, and reaching as high as 13% by the end of 1979 (after averaging around 2% throughout the previous decade). And third, Congress passed the Depository Institutions Deregulation and Monetary Control Act (DIDMCA) in 1980. Prior to the passage of DIDMCA, loan and deposit rates were fixed by the Fed; the Act allowed those rates to float with market rates.

In the aftermath of those three events or trends, Chairman Volcker began using a different set of policy tools to meet the Fed's objectives: he manipulated short-term interest rates, instead of using the money supply. To curb rampant inflation, Volcker immediately began to aggressively increase two key benchmark rates the Fed charged banks: the discount rate, and, more importantly, the Fed funds target rate. (The Fed funds target also determines the rate that banks charge each other to borrow and lend from and to each other to facilitate their liquidity needs.) Those rates determine other key rates, including the prime lending rate, which banks charge their most creditworthy customers. Most credit card rates are still tied to the prime rate. And the Fed funds rate also influences Treasury yields.

Since the Fed funds rate is basically an overnight borrowing rate, it's analogous to a regular savings account rate, but between banks, rather than for individual depositors. It's closely watched by market participants. Treasury yields are based in large part on expectations of what the Fed funds rate will be in the future.

We need to address how the Fed uses the Fed funds target to effect monetary policy. Recall that prior to DIDMCA, the Fed increased the money supply to stimulate the economy and promote full employment, and it decreased the money supply to rein in an overheating economy and thereby slow the rate of inflation.

In the time since the passage of DIDMCA (what we call "the monetarist era," which is still in place today, since the Fed still uses interest rates to effect monetary policy), the Fed increases the Fed funds target to slow down an overheating economy. This has the same effect as reducing the money supply, in that it makes borrowing more expensive. Businesses would be less likely to borrow and expand, so hiring would slow and wage growth would decelerate. Consumers would also be less likely to borrow and spend, so demand for goods and services would decline, thereby reducing the risk of inflation. (I'm only talking about the Fed funds target here, and not addressing the discount rate. The discount rate is important, but the markets focus on the Fed funds target.)

Conversely, when it sees signs of economic weakness, the Fed begins cutting the Fed funds target. The intent is to get businesses and consumers borrowing to stimulate the economy, thereby promoting full employment. (The Fed's definition of "full employment" is a moving target, but recent Fed Chairmen have defined it as a 5% unemployment rate. Obviously that's not "full" employment, but some people are always going to be unemployed at any given point in time, and historically, 5% is a pretty low unemployment rate.)

The Fed engages in these cycles of cutting rates ("easing") and raising rates ("tightening" or "hiking") proactively - or at least it attempts to. More often than not, the Fed gets it wrong, and especially over the last 25 years or so, they have a tendency to overdo it. They cut rates by too much and leave them too low for too long, and thus create asset bubbles that result in recessions. This happened in 2000 with the dot-com bubble and in 2008-09 with the housing bubble. (They created another housing bubble in 2021-22 that is currently in the process of correcting.) And they tend to get behind the market when it comes to raising rates, as they did in 2022 when inflation began to accelerate; as a result, they had to tighten more aggressively than they have since inflation was last this high, in the 1980s. However, a critique of Fed policy and its contribution to asset bubbles is another topic for another day.

Where is all this leading us in our discussion of the yield curve? The short end of the curve (under two years) tends to react to Fed moves, while the long end of the curve (especially the ten-year) anticipates longer-term future Fed moves. We'll talk more about that momentarily. First, let's talk about why the expectations theory means that a "normal" yield curve is upward-sloping. Then, let's address why certain maturities receive greater focus than others, something I alluded to in the previous post.

In general, as noted above, the market expects that the economy will grow over the long run. That means that the Fed will have to raise rates over the long run in order to keep inflation at bay, and that in turn means that long-term expectations of future interest rates will be higher than short-term rates are today. Thus long-term yields will be higher, based on those expectations, than short-term rates, and the yield curve will slope upward from shorter to longer maturities. Again, that's generally true, and only when the economy is growing.

Now let's turn to why certain maturities are more "important" than others. When we talked about the market segmentation theory, we noted that banks and credit unions tend to focus on the two- to five-year maturity range, thus those maturities are considered key benchmarks. Two years is about the average duration of a car loan, and many institutions maintain a similar duration for their investments, including Treasuries. And, looking at a typical graph of a "normal," upward-sloping yield curve, the five-year point on the curve tends to be an approximate inflection point, at which the long end of the curve begins to flatten out.

And finally, the ten-year yield is the benchmark yield for mortgage loans, because that's the approximate average duration of a 30-year fixed-rate mortgage loan. (Mortgages are priced at a spread to the ten-year yield for that reason.) Also, not that many investors, relatively speaking, invest in 20- to 30-year maturities. So 2s, 5s and 10s are considered the key maturities by bond market participants.

When the Fed raises rates, the two-year yield is almost always going to go up. The ten-year yield may go up, as long as traders and investors at the long end believe that future Fed moves will be to raise rates. However, if traders and investors believe that the Fed is done raising rates, or almost done, and that they're going to start cutting rates again soon, the ten-year yield may go down immediately after the Fed raises the Fed funds target. This is because, again, short-term rates react to the Fed, while long-term rates anticipate longer-term, future Fed moves. If the long end (meaning traders of long-term Treasuries) believes future moves will be lower, it will bid yields down based on those expectations.

As a result - and this is where we begin to get into a discussion of what the yield curve tells us about the economy - if the long end believes that the economy is weakening, and the Fed is going to have to start cutting rates longer-term, it will bid yields down: long-term yields will begin to fall in anticipation of those future Fed rate cuts. But if, at the same time, the Fed is still raising rates, because that economic weakness has not yet emerged, short-term rates may continue to rise in response to the Fed raising rates.

And that can lead to a yield curve that is the opposite of what we'd normally see, where long-term yields are lower than short-term yields. This runs counter to the liquidity preference and market segmentation theories, but is entirely in line with the expectations theory: the market expects the Fed to reduce rates long-term, but to continue to raise them short-term. The result is what we call an inverted yield curve:

In this graph, as of a few days prior to this writing, we see that the highest yield on the curve is the yield on the one-month T-bill, and the lowest yield is that on the five-year note. Even the 30-year bond yield is less than any of the T-bill yields, because long-term traders and investors expect the Fed to begin easing soon, because of emerging economic weakness. This is in spite of the fact that, the day after the date of this graph, the Fed increased the Fed funds target rate.

The yield curve is currently inverted, and it has been since July 2022. The general measure of inversion is the spread between the ten-year yield and the two-year yield. Here's an illustration of that spread since about 1996 (note that the curve was inverted, illustrated by the spread between the ten-year and two-year yields dropping below zero, prior to the recessions that began in 2001 and 2007, depicted by the areas shaded in gray) :

In summary, we've discussed the three theories that determine the shape of the yield curve. We've established that a "normal" yield curve is upward-sloping, with long-term yields higher than short-term yields. We've also established that when the market anticipates economic weakness, it assumes the Fed is going to cut rates, and thus long-term expectations are for lower rates, even if short-term rates are still increasing, which can result in an inverted yield curve.

What we can derive from this is that an inverted yield curve is a leading indicator of a recession. In fact, nearly every recession in the U.S. has been preceded by an inverted yield curve. It's vitally important to note that this is not a cause-and-effect relationship: an inverted yield curve does not cause a recession; it results from market participants' expectations that there will be a recession, and how the Fed will respond to it in its policy actions.

Armed with this information, in our next installment we'll turn to a discussion of inverted yield curves and recessions, some erroneous conclusions about other yield curve signals as they pertain to impending recessions, and another misconception about leading indicators of recessions.