By Paul Kiernan
WASHINGTON -- Fresh data suggesting the global slowdown may be
intensifying caused a widely watched bond-market indicator to flash
its first recession warning since 2007 on Friday, raising
expectations the Federal Reserve may cut interest rates by year's
end to counter the economic headwinds.
The latest developments represent a stark turnaround from
December, when Fed officials raised rates amid strong growth, tight
labor markets and steady inflation. Since then, the picture has
been muddied by choppy U.S. economic data, a record-length
government shutdown, global trade tensions and the U.K.'s
unresolved Brexit plan.
The latest signs of trouble came Friday when a report showed
factory output in the eurozone fell in March at the fastest pace in
six years, while a measure of U.S. manufacturing activity slid to
its lowest level in almost two years. Those data followed a
Thursday report showing U.S. services-sector revenues slowed more
than previously thought in the fourth quarter, prompting several
economists to lower their growth estimates.
The drumbeat of unsettling news Friday drove the yield on
10-year Treasury notes below that of three-month bills for the
first time since 2007. That situation, known as an "inverted" yield
curve, has preceded every U.S. recession since 1975 and is viewed
by many investors as a reliable predictor of downturns.
Traders in futures markets by the end of the day Friday had put
a 58% chance of at least one Fed rate cut by the end of this year,
up from 11% a month ago, according to CME Group.
"It's very clear that the economy at this point is losing
momentum," said Lindsey Piegza, chief economist at Stifel. "I think
the risk of turning negative is rapidly rising."
Most economists still think the economy is on solid footing, as
does the Fed. On Wednesday, policy makers at the central bank
projected U.S. gross domestic product would expand 2.1% this year
and 1.9% in 2020, down from 3.1% last year but slightly faster than
its long-term potential.
Chairman Jerome Powell said at a press conference Wednesday that
the Fed has "a positive outlook for this year, a favorable outlook
for this year, " underpinned by rising wages, low unemployment and
high levels of household confidence.
But Mr. Powell also pointed to a number of risks, such as
slowing growth in Europe and China and uncertainty surrounding U.S.
trade policy. While fiscal-stimulus measures shielded the U.S.
economy last year from such headwinds, the effects of 2017 tax cuts
and 2018 spending increases are fading.
Further clouding the outlook, the U.S. government shutdown in
December and January delayed the release of most official economic
data, making it hard to gauge how much steam the economy has
lost.
"The limited data that we have do show a slowdown," Mr. Powell
said Wednesday.
But he stressed it wasn't clear which direction the Fed's next
interest-rate move should be. "We're going to watch carefully and
patiently as we allow events to evolve, and when they do clarify,
we will act appropriately."
An additional risk is that the Fed's four interest-rate
increases in 2018 -- the last of which occurred in December -- may
not yet have been fully felt. It can take many months for such
policy changes to work their way through financial markets and the
broader economy.
"Even though the Fed has stopped raising interest rates, it's
possible we'll have some impact that we'll be feeling for a while
in terms of slowing the economy," said Danny Bachman, an economist
at Deloitte Services LP.
Given the latest data and signals from the bond market, some
said the Fed should look to reduce interest rates to keep the U.S.
from following its trading partners into slowdown.
"To prevent recession next year, the Fed should cut rates this
year by enough to keep the yield curve" from inverting, Marc
Sumerlin of Evenflow Macro, a policy analysis firm, wrote to
clients Friday. "Right now, one rate cut is justified, but a
growing global downturn would justify more."
After a blockbuster year for U.S. companies, analysts are
expecting corporate earnings to moderate in 2019. FedEx Corp.,
whose shipping business is often seen as a bellwether for the
broader economy, cut its outlook this week for the second
consecutive quarter, citing weaker macroeconomic conditions and
global trade trends.
A yield-curve inversion is considered a warning sign because it
implies bond investors think a weakening economy will require
interest rates to be lower in the future than where the Fed
currently has set them. While the yield curve has inverted before
every recession in recent decades, it has also inverted without a
recession following until several years later, and economists think
some changes -- in particular central bank bond-buying -- may have
muted its signal.
St. Louis Fed President James Bullard said in an interview
Friday that the inversion was "mildly concerning," adding, "I'm
hopeful this is just temporary." A sustained inversion, he said,
would worry him considerably.
Adam Slater, a lead economist at Oxford Economics, said the
indicator isn't foolproof, but isn't something that can be ignored,
either.
"Clearly the bond markets are taking the view that not only
might we not have any more rate-increases in the States, but we
might be thinking about policy easing again in the not-so-distant
future," Mr. Slater said.
Fed economists have developed a variant of the yield curve that
filters out the effects of central bank bond-buying, thus
generating fewer false recession alarms. It compares the
three-month Treasury-bill yield today to where the market expects
it to be in 18 months. That spread is now negative, according to
JPMorgan, corroborating the yield curve's warning sign.
In a survey of economists this month by The Wall Street Journal,
the vast majority of respondents predicted the next recession would
begin in either 2020 or 2021. The odds of the U.S. falling into
recession in the next 12 months were placed at 25%, up from last
year but little changed from the prior survey.
Since the last recession ended, the world economy has suffered
two defined slowdowns, economists say. The first, in 2011 and 2012,
was driven by the European debt crisis and fiscal tightening by
congressional Republicans in the U.S. The second, in 2015 and 2016,
was characterized by low commodity prices that hit emerging-market
economies especially hard.
--Michael S. Derby contributed to this article.
Write to Paul Kiernan at paul.kiernan@wsj.com
(END) Dow Jones Newswires
March 22, 2019 18:27 ET (22:27 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.