In my most recent OC Leader Board article, I showed that year-to-year changes in job growth had declined rather steadily from 1.91% growth in January of this year to 1.49% in July. Last Friday, Sept. 6, it was reported that job growth slid to 1.39%. This drop-in job growth continues a trend that will push job growth ominously close to 1%, as shown in Chart 1.
The reason I use the word “ominously” is because since 1967, every recession began when job growth dropped to 1%. This can be seen in Chart 2. The usual explanation for this historically consistent pattern is that job growth below 1% is not sufficient enough to absorb the natural increase in new job seekers, thereby leading to increasing unemployment.
While it’s premature to make a recessionary call based on the current downward trend in job growth through August, other storm clouds are forming.
The yield curve, measured by the difference between the 10-year Treasury bond and the 90-day Treasury bill, is also sending recessionary signals. With only one exception, the difference turned negative with the short rate (T-bill) exceeding the long rate (T-bond), a recession invariably occurred.
The consistency of this recessionary indicator is shown in Chart 3. Notice that even the back-to-back recessions between 1980 and 1982 were preceded by two distinct periods where the yield curve turned negative. While the yield curve didn’t quite turn negative before the 1990-91 recession, it dropped sharply to almost zero (0.27) in the third quarter of 1989.
There are two principal reasons often cited by economists as to why an inverted yield curve so reliably signals an imminent recession. One is that declining long-term rates signal greater pessimism about future growth prospects for the economy. The other view is that an inverted yield curve makes it difficult for financial institutions to lend profitably when their cost of funds (short-term rates) exceed their lending rates (long-term rates). The sharp decline in business investment during the recent quarterly report on real GDP growth provides support for that view.
But there are many analysts who argue that the inverted yield curve is giving off false recessionary signals and is not something to worry about, at least this time around. The most compelling reason for this relates to the huge amounts of foreign investment in U.S. bonds serving to push down long-term rates like the 10-year T-bond.
That would suggest the drop-in rates are not because of pessimistic investor attitudes, but because of a seemingly insatiable appetite on the part of foreigners for U.S. treasuries. A little-known statistic I presented at the recent Chapman Forecast Update gives some credence to that view. It showed that foreign ownership of government debt spiked upward at an annualized rate of 14.2% in the first quarter of this year.
In spite of this, I believe, it’s foolhardy to ignore the recessionary signs of an inverted yield curve. As shown in Chart 3, it’s just too reliable an indicator to discount.
The yield curve turned negative three quarters before the start of the ’89 to ’90 recession, two quarters before the 2000 recession and five quarters before that start of the ’07 to ’09 recession. Since the yield curve inverted in the second quarter of this year, the varying lag between yield rate inversion and recession would place the start of the next recession sometime in early 2020. If job growth drops to 1% or lower by year-end, that would be another reliable indicator pointing in that direction.
While it may be too early to make a recessionary forecast, it’s getting close.
Given the storm clouds that are forming, I think it’s time to batten down the hatches.
Editor’s Note: James L. Doti, Chapman University’s president emeritus and professor of economics, is one of the nation’s most accurate forecasters.
