Is a recession coming?

By Farrokh Langdana, Director, Executive MBA Program & Professor of Finance and Economics  

Faculty Blog: http://www.business.rutgers.edu/faculty/farrokh-langdana

The question is on everyone’s minds:  "Now that we have major inversion, is a recession coming?" I have gone over this before [see blog: "Requiem for a stock market rally"], but the recent yield curve inversion (8/14/19) and the subsequent market selloff that occurred that day – the Dow was down - 6.1 percent and the S&P -5.7 percent – calls for a fresh examination.

Intuitively, a longer-term bond should offer a higher return than a short-term bond. That’s why it’s big news when the yield on a 10-year U.S. Treasury (1.623 percent) becomes less than the yield for a 2-year U.S. Treasury (1.634 percent).

The yield curve inverts when expectations of future inflation plunge. There can be several reasons for this:

1. A collapse in future economic activity heralded by a loss in consumer and investor confidence. (The Aggregate Demand slumps hard to the left due to expected future drops in economic activity and confidence).
2. A massive positive productivity shock from new innovation that pushes down expectations of future inflation. (The Aggregate Supply Curve happily shifts right, as it did after the advent of the Internet).
3. Massive capital inflows flooding into the U.S. Safe Haven – which would depress the entire yield curve and not necessarily invert it, unless capital is drawn primarily into longer-term Treasuries, thereby increasing the longer-term supply of loanable funds, dropping long term interest rates and pushing down the long end of the yield curve.  

So, is it #1, bad global leadership, irresponsible budget deficits, and the inevitable effects of picking trade wars? 

Or is it #2, huge productivity gains?  The iPhone 11 will change the world, right?  I will be able to cure my knee pain by just talking to an app, right?  

Or is it #3,  massive inflows?  And this even though the Germans and the Chinese have slowed purchases of Treasuries. What might happen if China stopped buying U.S. government bonds?

One of our Rutgers alums, CEO Jeffrey Hermann of Hermann Trucking, has been warning me for several months of a massive current and ongoing slowdown in transportation. He warns that the future for trucking is looking even more bleak; and this is above and beyond the drop due to lower global trade.  And please note, a large part of trucking is Amazon.

How about transportation for the planet, especially in shipping materials by sea for infrastructure spending? The Baltic Dry Index is actually up, but it is an Identification Problem since there are fewer bulk cargo ships in the water now, many have been pulled out.

So, is a recession coming? You make the call.  

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