EC Here Be Monsters? U.S. Economic Expansion Enters Uncharted Waters

On July 1, America entered unknown economic territory. The U.S. is now in the 11th year of continuous economic expansion without a recession to blemish the record.1 This is the longest the nation has ever gone without falling into an economic downturn. Paired with the country’s equally-impressive equity bull market—which officially became the longest in U.S. history in March2—2019 has become a year defined by record highs.

But the good times won’t last forever. Slumping global growth, heightened trade tensions and diminishing levels of business confidence and manufacturing suggest that the economic expansion is running out of steam. But when exactly might it breathe its last?

Divergent views in equity and bond markets

Not surprisingly, markets have been obsessing over this question for the better part of the year. In fact, ever since the equity market sell-off in the fourth quarter of 2018, this appears to have been the central question driving market performance. For the first four months of this year, investors were clearly betting that with the U.S. Federal Reserve (the Fed) on the sidelines and unlikely to raise interest rates—which could have posed a serious threat to future economic activity—the economy would not slip into recession in the near-term. This allowed markets to rally significantly from their early-January lows, with the S&P 500® Index posting a year-to-date return of 18.25% by the end of April.  

Meanwhile, the bond market was not basking in the same sense of optimism. While stocks were rallying, so too were bond prices, as interest rates fell significantly by springtime. By the end of April, the yield on the benchmark 10-year U.S. Treasury note had sunk 28 basis points from its mid-January high, down to 2.51% from 2.79%. While rates were falling, the yield curve was also flattening, meaning long-term and short-term interest rates were coming closer and closer to each other. As a rule, significant drops in interest rates generally mean the bond market is concerned that economic growth is about to slow. The flattening of the yield curve that occurs as longer-term rates drop while short term rates remain the same is called a bear flattener. The worries in the first few months of the year were very likely based on the fear that the Fed might have already gone too far in raising rates—to the point where monetary policy could be considered restrictive. Indeed, many economists feel that the catalyst for most U.S. recessions is a Fed that raises interest rates too high, thereby slowing economic activity to the point where it starts to contract.

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Disclosures These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page.

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