Currently, the interest rate on short-term bonds is lower than the interest rate on long-term bonds. The reason is clear: when a lender partes with his money for a longer time, he gives up liquidity and also takes greater risks from the unknown and from changes in the value of the money. When this rule is reversed, i.e. the interest rate on short-term bonds is higher, it is a rather rare phenomenon known as the “inverted yield curve”.
Such a phenomenon, where the interest rate on the 10-year bond is lower than that on the 2-year bond, has occurred six times since 1976. Each time, the interest rate on the 3-month bond was also higher than that on the 10-year bond years And each time the reversal was followed by a recession, usually within two years. Usually the periods of recession started precisely after the reversal disappeared, and the interest rate returned to normal. The reason for the return to normality was always the lowering of the interest rate or a high expectation of such a lowering. The short-term bonds are significantly affected by the short-term Fed interest rate, and therefore this lowering also lowers the yield on them.
About two years ago, a reversal began in the yields of the two-year bond versus the ten-year bond, and about a year and a half ago it also happened with the 3-month bond. In March of this year, the reversal broke a historical record when it crossed the 624-day line, a record held by the reversal of 1976. Although it is a long and distinct reversal, and the third deepest, higher than that of 2008 and 2000, meanwhile the American economy shows no real signs of weakening. The main reason is that despite the sharp increase in interest rates, the prime interest rate stands at 8.5% and that on mortgages is over 7%, and a significant portion of the non-government debt is locked in at a low interest rate for a relatively long period of time. According to a study by the real estate company Redfin, about 89% of consumer mortgages in America have a fixed interest rate below 6%; 59.5% have a fixed interest rate below 4% and 22.6% have a fixed interest rate below 3%. In the corporate bond market The situation is similar. Less than 13% of them are due and renewed in the next 12 months, including the weakest bonds, rated B-.
The likelihood of a recession is at a record high that hasn’t been seen since the 1980s
Nevertheless, slowly the clouds on the horizon are accumulating. A model of the New York Federal Reserve Branch that analyzes the probability of a recession within 12 months, states that the probability of this today is 50.4%, a number that has not been the same since the eighties of the last century. For comparison, in 2001 and 2009, which were recession years in many countries, the model showed a lower probability of a recession developing.
Although the GDP data and employment reports are far from indicating a recession in the US, the trend is clear. In the first quarter of this year, GDP rose at an annual rate of about 1.6%, a sharp drop from 3.4% in the last quarter of 2023. The employment report for April is also flashing yellow. According to the report, the American economy added 175,000 new jobs in March, much less than the 235,000 expected, as well as the 315,000 jobs in the previous month.
Fewer building permits and contraction in procurement
These data are consistent with other important indicators. Thus, the purchasing index in the manufacturing sector (ISM Manufacturing PMI) now stands at 49.20, a decrease of 2.19% from last month, and lower than the expectations which were about 52. Real estate also indicates a slowdown. The number of building permits issued in March fell by 2.3% compared to the month before, to the lowest number since September.
The US economy is based about 70% on consumer spending. These decreased in the first quarter of the year by about 0.7% in real terms. This fact corresponds with another index, consumer sentiment, which is measured monthly by the University of Michigan. It fell this month, from 77.2 last month to 67.4 now, the lowest in six months, and well below market expectations of 76.
Bankruptcies are also on the rise: according to data from the Courts Administration, the number of private bankruptcies increased in 2023 by almost 17% compared to the year before, and those of businesses increased by approximately 40.4%. In the first quarter of 2024, the trend continued, and business bankruptcies increased by 22% compared to the corresponding quarter, and those of consumers increased by 13%.
A similar trend was also evident in the real estate sector. According to Atom, the leader in collecting information regarding this market, in the first quarter of 2024 the number of houses in foreclosure procedures increased by 3% compared to the fourth quarter of last year. In April, the number was large. By 8% from April last year, the number of transactions also fell dramatically. According to the research company, the number of houses sold in March this year fell to 4.38 million in January 2022 and 6.65 in January 2021. According to the Federal Reserve, the median house price in America fell from about $480,000 in the fourth quarter of 2022 to about $421,000 at the end of the first quarter of 2024.
Last week the Federal Reserve of New York published another alarming statistic. In the “Household Debts for the First Quarter of 2024” report, it is written, “Debts for the purchase of vehicles and those on credit cards that have gone into serious insolvency, i.e. more than 90 days in arrears, continued to increase in all age groups. As of the end of March, 3.4% of household loans were found to be in some degree of arrears. In an annual calculation, 8.9% of the total credit card debts and about 7.9% of the total car loans are in a state of non-payment, testifying to how much the financial situation of households is getting worse.
The current decade has already overtaken its predecessor in rising prices
The high interest rate slowly cools the activity in the economy, and accordingly the inflation. The core index (Core CPI, the fixed basis found in the product basket), the one favored by the Fed, is still hovering above 3.5%. This figure shows how easy it is to print – almost 20 trillion dollars of debt money reached the market in America from the second quarter of 2020 to the end of 2023, an increase of about 25% in the money supply – but it is difficult to get rid of the results of printing. We are not yet halfway through the current decade, but the price increases in America since the beginning officially stand at about 22% – and in practice they are much more – they exceeded the total price increases that were in the entire previous decade, about 18.6%. This inflation not only erodes the purchasing power of the absolute majority of the public, it also erodes savings, especially those invested in bonds and deposits. These pay the full inflationary erosion, and also usually bear the payment of capital gains tax on these inflationary “profits”.
The high interest rate is having a hard time lowering inflation, but in the meantime it is wreaking havoc on the international currency markets. Thus, the Japanese yen, despite the intervention of the Central Bank of Japan, is trading in the area of 160 yen to the dollar, a low that has not been seen in 34 years; The Canadian dollar is hovering around 73 cents to the US dollar, its lowest point since 2004; And the US dollar index stands at a peak not seen since 2002, except for a few months last year, far above the multi-year average.
In the meantime, the Fed’s interest rate policy is piling up increasing difficulties for the regional banks. A significant part of the credit portfolio of these banks is concentrated in commercial real estate, a sector whose debts, according to Moody’s, amount to 4.5 trillion dollars. According to a report by the Fidelity Fund, about 51% of the sector’s debts are to banks, of which 16.7% for office buildings. On average, bank credit for commercial real estate accounts for over 40% of the credit portfolio of the hundreds of medium and small regional banks in America, and over 10% for the 12 largest banks. For example, JP Morgan has about $173 billion of credit for commercial real estate, 13 % of his total credit portfolio. According to the report of the National Bureau of Economic Research (NBER), about 14% of the loans in the sector in general and 44% of the loans on office buildings are in a “negative capital” situation, that is, the amount of the loans is greater than the value of the assets pledged to the credit, in view of the fall in the value of the assets since 2022 .
The Fed will be forced to lower interest rates in the coming months
The growing difficulties in the sector found expression not long ago in the balance sheets of the regional bank “New York Community Corp”. About a year ago, it was ranked as the 32nd largest bank in the US, with $113 billion in assets and a share capital of approximately $8.4 billion. In the last quarter of 2023, as well as in the first quarter of this year, the bank posted heavy losses, and its stock crashed by 80%. To the sector Commercial real estate was a significant part of this. About two months ago, the bank received a lifeline: a billion dollar investment from several Wall Street companies. This bank is no exception: in the next 12 months, about a trillion and a quarter dollars of commercial real estate loans are expected to arrive for repayment and renewal. The interest rate will play a key role here, both in the evaluations of the theoretical value of the securities and in the analysis of the expected net payment flow. Therefore, the Fed’s decision regarding the interest rate There could be a far-reaching effect on the stability of the entire American banking system, and in particular the regional banks, which make up the majority of banks in America.
The rapid changes in interest rates in this decade, and the massive printing since the outbreak of the Corona until 2022, will soon reach money time. If history can teach anything, the Fed will be forced to lower interest rates in the coming months, despite the fact that inflation has not yet been conquered. With the lowering of the interest rate, and even in the process of waiting for it, the inversion of the yield curve will begin to straighten out, and the stock market may well react with a burst of enthusiasm. But what awaits several quarters later is much less optimistic, if history repeats itself and the models are not mistaken. Within a few quarters the recession will arrive and with it a sharp drop in the stock markets. After that, a massive quantitative easing will return and an interest rate cut, with which the inflation that has not yet subsided will return. These will further drain the public’s savings, and in particular those invested in bonds and cash. Thus another round will begin, of the type that will probably accompany us into the next decade with higher intensity and frequency than before.
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