Monday, 10 Dec 2018
Business

It's not just Trump's trade war. This is what also worries the markets.

One thing we can say is that the markets do not seem to like having a "tariff man", as President Trump himself described it in the White House. Not when shares sold more than 3% in response to Trump's latest 280-character trade barrier ode, as he partially escaped his previous assurance that he would be able to conclude an "incredible" trade deal "with China.

To be fair, however, that was not the only reason markets had such a disastrous day. Indeed, it was perhaps not even the most important. This is because our most accurate recession predictor – the difference between the government's long-term and short-term borrowing costs – has gone from blinking yellow to a level extremely close to red.

Specifically, the interest rate differential between 10-year US Treasuries and two-year bonds reached a new low of 11 years at 0.12 percentage points. As anyone who has a mortgage can tell you, things do not work normally. After all, you usually have to pay a much higher interest rate to borrow money over a longer period. So why the opposite – what's called an "inverse yield curve" – ​​would it be for Uncle Sam?

The answer is that since the US government is generally considered the safest borrower in the world, its long-term borrowing costs are only a function of what its short-term borrowing costs should be at the future. Which, although it may seem simple, is actually quite deep. This is because short-term interest rates are themselves dictated by the state of the economy: the Federal Reserve raises them when things go well to prevent inflation from rising too much and reduces them when things are not going well enough to prevent unemployment from rising too much. Overall, since long-term rates are lower than current short-term rates, markets believe that short-term rates will fall tomorrow, which would not happen if the recession were felt.

Now, if you're a guy at the half-full yield curve, you point out that Federal Reserve Chairman Jerome H. Powell recently seemed to say he might not raise his rates as much as expected. . Or that the head of the Dallas Fed, Robert Kaplan, thinks they can afford – and need – to be from now on very patient. Or again, Minneapolis Fed President Neel Kashkari does not see the need to raise interest rates at all yet. But if you're a person with a half-empty yield curve, you'll say the markets probably read too much of it in Powell's rather innocuous comments. Or, Fed governor Lael Brainard, who was one of the most accommodating members of the central bank, seemed to downplay the risk that they would raise short-term rates above long-term rates. in a speech in September. Or that a small part of the curve – the difference between the five-year and three-year bonds – is already reversed a few days ago.

All this to say that the dark border with what has been our money cloud of good economic news suggests that it is getting a little more disturbing now. It may seem hard to believe when interest rates are only 2.25% and unemployment is only 3.7%, but the fact is that we are still sufficiently stuck in the shadow of the Great Recession so that it does not take much. to get out of the virtuous circle in which we find ourselves. Slightly higher interest rates could do that. So could a trade war. Or maybe the slowdown in the rest of the world catches up with us. The fact is, for the first time in a long time, there are real reasons to worry about the recovery. They are not there yet, but they could be soon – if the story is a guide, maybe in the next 12 to 18 months.

In this case, Trump could be what no president wants to be in an election year: a man in recession.

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