What a week in the markets, huh? The VIX had us thinking the world was about
to end, only for the market to close with one of its best weeks since October
'23. We've even heard whispers of emergency rate cuts—imagine that! Are
speculators exaggerating? Is the excessive yen borrowing really that big of an
issue? Or are we just witnessing a normal return to the mean? Markets do tend
to correct, even in bull runs. I'd love to say we're heading into a
multi-decade bull market and that this was just a correction, but some
indicators are signaling a recession. Let's take a look.
First, we need to consider the Sahm Rule, arguably one of the most accurate
recession indicators. In short, the rule examines the three-month average U.S.
unemployment rate and whether it rises by more than half a percentage point
within a one-year period from its low. If this is the case, the U.S. is in a
recession, which most likely spreads to the rest of the world. Take a look at
the FRED chart below—I've confined the data to the last four recessions only.
If the Sahm Rule increases by more than 0.5 percentage points (which occurred
in July), it usually signals that the U.S. is already in a "silent" recession.
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If we examine the U.S. unemployment data, we can clearly see the rise
following a period of very low unemployment (average 3.5%). Historically, a
rise from these levels has pushed the U.S. into a recession (indicated by grey
areas). This pattern occurred in the late 50s, early 70s, and early 00s. The
same happened before COVID, but that's arguably an exception given the
unpredictability.
Looking at the bond market, we see a similar story. We've witnessed the
longest yield curve inversion in history—approximately 760 days—and it's close
to ending, with the 10-year yield currently just 0.115% lower than the 2-year
yield. Historically, the flip back to a positive slope after such lengthy
inversions has occurred just before recessions.
So, what's your take? Are we heading into a recession and subsequent bear
market or is all of this blown way out of proportion? Let us know!