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Is the US facing a recession?

Investors express disquiet

How long can an economic expansion last? It’s a key question for US investors, who are currently enjoying one of the longest periods of uninterrupted growth on record. But for some, there are unsettling signs about the health of economic growth, with recession signals like the US yield curve now flashing amber.

Why does a technical signal like the US yield curve matter?

When the yield curve inverts (i.e. when long-term government bond yields fall below short-term yields), a recession is typically 24 months away. While the yield curve is one of the most accurate recession predictors, there are several reasons why it might not be a good idea to immediately sell shares.

Perhaps surprisingly, stock markets still tend to deliver positive returns following an inversion in the yield curve. US stocks have historically delivered a return of 14% in the twenty four months following an inverted yield curve, with investors who sold early often missing out.

And although the yield curve has historically proven accurate, it may be less valuable as a forward looking indicator nowadays. The yield curve is only accurate because it reflects where investors are happy to park their money – investors don’t want to buy bonds if the economy is performing strongly.

In recent years, that signal from investors has been distorted. The Federal Reserve bought US government bonds to help stimulate the economy after the financial crisis, lowering long-term bond yields, and making it easier for the yield curve to invert. The Federal Reserve’s ‘artificial demand’ for US government debt might therefore be sending a false signal about the prospects for the economy.

Are there any weaknesses in the real economy?

The main weakness in US economic data concerns the manufacturing sector. US industrial production unexpectedly fell in April, and the ISM manufacturing index fell to its lowest level since late 2016.

While manufacturing tends to be a lead indicator for the economy, it is not a perfect. We saw a similar picture in late 2015 and early 2016 for example, when many industrial companies were hurt by a falling oil price. Weak industrial production today can partly be attributed to cold weather and trade tensions between the US and China.  For the meantime, the customers of many manufacturers are drawing down their stockpiles, rather than buying new products and spending money they may need later on.

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