Thursday, August 15, 2019

Correlation is not Causation

When the 10 and 2 year bond yields inverted yesterday, the markets freaked out. Every recession since 1950 or some ancient time as been preceded by a yield inversion. But on the flip side, not every yield inversion has been followed by a recession. And the recessions, if they do come, come much later, like up to 2 years later. 

So yield inversions do not cause recessions. They are just a measure of imbalance in the bond markets. 

What does cause recessions? A contraction of activity in the economy. Business slowdowns, housing market weakness, a reduction in liquidity, cost of money (credit cycle and Federal Reserve policy), asset bubbles, and a host of other events can cause recessions. It normally takes more than one thing to cause a recession. 

But the U.S. economy -- in most regards -- is still doing just fine. 

Kelly Evans at CNBC (my favorite mid-day newsletter) said this: 

The U.S. data came in strong again this morning. Jobless claims have barely budged; the regional Philadelphia and New York manufacturing surveys continue to shake off their earlier slumps; retail sales were super strong, helped by--no joke--Amazon Prime Day. But that wasn't just a quirk; the retail gains were broad-based, putting consumption on track for another 3% quarter.

And there's more! Productivity is up 1.8% on the year now. Hourly compensation is running a nice 4.3% over the past four quarters, per economist Stephen Stanley. That's great news for workers (although not so much for profit margins) and should help dispel some of the deflation fears out there. 
All of this was enough to push the 30-year Treasury yield back above 2%, which itself feels like a ridiculous thing to write. Back above 2%?! It had never in U.S. history slipped below that level until last night. And we couldn't even hold it. We're back below 2% as of this writing.
So I'm not freaking out. And I'm still mostly in cash, except for a few stocks and inverse ETFs. The market is still overvalued by two measure I follow: The Shiller PE ratio and the Buffett indicator

Phil Town, on what causes recessions.

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