There is an old adage in economics that says, “Economic expansions don’t die of old age.”  Heck, the San Francisco Fed even did a study in 2016 on the topic, aptly titled: “Will the Economic Recovery Die of Old Age?”  Their conclusion: “Expansions, like Peter Pan, endure but never seem to grow old."  If this is indeed the case, how do we know when an economic expansion is about to end?  The same way we know when our time at the driving range needs to end, maybe we run out of balls to hit or we run out of daylight.  In other words, we run out of vital resources.

According to my research, the US economy is no different.  When we analyze the resources used to fuel an economic expansion, like employees, profits, production capacity, debt, etc. we can get an idea of what might be left to prolong an economic expansion.  The chart below provides a relative look at economic resource utilization, and according to it, we may be getting close to tapped out for this expansion.


 
Not only are business resources getting scarce, but the same may be true for the consumer.  There seems to be no shortage of opinions out there about the impact of rising rates on our economy and more importantly, the consumer.  I have always said the rate of change of interest rates is a much more important measure than the absolute level of interest rates.  When we do the same relative analysis on taxpayer’s interest expense burden, as we did for resource utilization above, it becomes very apparent that rates have risen high enough, relative to the size of outstanding debt, to start to crimp the consumer.  They may be running out of resources as well.


 

So far, this is the 4^th longest post-war expansion for the U.S economy.  While it may be true that expansions don’t die of old age, they can surely die by running out or resources, and it is becoming more evident we are reaching that point.

Over the years, one of my favorite mantras has been “the bond market it the smartest animal on the planet”.  Historically, ignoring the message the bond market gives us, tends to lead to financial pain of some sort for someone.  So, needless to say, I always feel better when my leading indicators/models seem validated by the bond market’s message.

At the 2018 ALMEdge conference held in April, I made the case that my long leading indicators were signaling potential trouble for the U.S. economy in late 2019.  In my June newsletter to subscribers, I narrowed that window down.  I stated that the likely start date of a recession would be December 2019 (18 months out from that publication).  I received several phone calls on how I got to that date.  I got to that date by applying some math to the bond market’s current message.  Specifically, the message transmitted through the spread between the 10-year Treasury and the 2-year Treasury (Spread).

In the chart below, I regressed roughly the last 2 years of data on the spread and then forecast that trend into the future.  IF that trend continues, the most likely yield curve inversion will take place in January 2019.  Based on average lead times of an inversion vs. a recession start date, the most likely recession start date is December 2019.  The good news is that is more than one year out, the bad news is, if the curve does invert, the message from my leading models will likely be vindicated.  Your ALCO committee should start formulating a plan on how to respond with asset and liability duration strategies if the yield curve actually inverts.  This is only a forecast but risk management would deem that you stay tuned!

Fads come and go.  Trends remain until they don’t.   It is amazing how quickly we forget them once they are gone.  Funny thing is, they tend to re-emerge without us even noticing.   I think we are in the midst of this very circumstance in community banking today.  I think it has been so long since we have had “pricing power” on our loans, we may have failed to notice a new trend emerging.
 
The National Federation of Independent Business (NFIB) claims to be America’s leading small business association, with upwards of 325,000 business owners.  I don’t doubt that claim.  To me, this is a huge resource pool for gathering information about the reality of life for America’s small businesses.  Better yet, the NFIB seems to agree with me.  Each month, they release a detailed survey to their members on everything from earnings and hiring, to regulatory headwinds and banking.   That’s right, banking!  The NFIB takes the survey results and creates its Small Business Optimism Index.  There are many useful data nuggets in this survey, but the one I wanted to highlight to you today is contained in the “Small Business Credit Conditions” section of the survey results; “RELATIVE INTEREST RATE PAID BY REGULAR BORROWERS."  It looks at the net percent, compared to three months ago, of respondants paying higher interest rates on new borrowings.  In the chart below, you can clearly see the re-emergence of a long forgotten friend of ours, loan-pricing power.



 
This index now stands at the highest level seen in 11 years.  It indicates that regular borrowers are paying higher interest rates on new borrowing.  In general, bankers I have talked with recently are still saying that the lending environment is still too competitive, and if you want new deals, you have to offer the lowest yield.  The trend in the chart above clearly shows SOMEONE is raising loan yields, and businesses seem happy to borrow at those higher rates.  I hope this re-emerging trend doesn’t pass you by.