The US Economy, according to several of my models, has entered a critical period. I have written about the first chart numerous times, alerting all to the impending economic liquidity cliff that the business cycle was headed for. As you can clearly see, we have gone over that cliff and, sadly, it only gets worse from here. As a reminder, economic liquidity refers to things like bank lending, reserve growth through Fed activity and changes in interest rates. Typically, economic liquidity takes a while to filter in and out of the economy and often has a "lag" time associated with it. For the US economy, those lags are over and the economic liquidity required to grow the US economy is contracting.
If we take the next step and look how the drying up of economic liquidity is affecting the actual economy in real time, we see, through the chart below, a good portion of the US population and small businesses are now experiencing what feels like the beginning of total a recession. Portions of the US economy have already been in recession for a while; manufacturing, housing, transportation just to name a few sectors. The service sector and employment sectors have been the saviors up until recently. But as the model below shows, when we compare current data to historical data during recessions, the model has signaled correctly the beginning of all recession since the early 80's and it turned negative the first week in October.
Now, typically, a recession is accompanied by falling interest rates, especially the FF rate. If we look to the bond market for confirmation of my models above, you find a key bond interest rate relationship is now signaling rate cuts are near. The chart below simply shows the One Year Treasury vs the FF rate. As you can see, at critical business cycle turning points, the one year falls below the FF rate. This is a signal to the Fed that monetary policy is too restrictive. The timing here varies but the message is always the same.
All of this taken together presents an opportunity for all of us to be proactive risk managers. The FF and EBA rates are very attractive and comforting right now, but they have a one day duration. When the Fed cuts rates, these rates will fall immediately and sharply. Even worse, Treasury yields will fall sharply too. The last time you had the opportunity to own yields like this in your bond portfolios was 15 years ago!
Remember, this is one man's opinion on what he sees. I could be wrong, but the evidence is growing quickly that a falling rate environment is likely closer than most think.