The economic landscape has undergone a radical swing from an expected recession to a somewhat stable footing in a very short time.
In his speech last week, the Chairman of the US Federal Reserve, explained how the economy is now on a path to solid growth. This is a radical change in tone from just last month when the Fed cut their interest rates due to uncertainty ahead.
If forecasting the economy is like forecasting the weather, we’ve gone from winter to summer in about two weeks. It boggles the brain and I don’t buy it!
Following on the heels of Great Britain, Germany produced some slightly reassuring data showing 0.1% growth in their economy thus narrowly avoiding an official recession.
The ‘return to growth’ celebration is without much joy however as the country’s economy is still considered fragile. What’s more, it still faces a major headwind as President Trump’s trade war increasingly focuses on Europe’s automotive exports.
The GDP data was possibly the worst thing that could have happened. Had the number come in negative as economists had forecasted by analysts, there would have been a strong case for the Government to come in with a strong hand and provide generous stimulus measures.
It’s apparent that the DAX index is having trouble rallying on the news because they’re quite familiar with the dilemma that this unexpected growth presents. But what’s more interesting is the rally we’ve seen in the last few weeks leading up to this moment that has the index very close to its all-time highest level.
If there’s any question where this excitement is coming from, look no further than the European Central Bank who have re-kindled their quantitative easing program. Starting in November they’re pumping €20 billion a month into the economy. Let it be known that this was never about growth.
Behind the Scenes
Where did these whispers of a recession come from in the first place though?
Well, most analysts who were predicting doom based their projections on the yield curve. The fact that short term bonds were paying more than long term ones was a clear indication that institutional traders were forecasting trouble ahead.
Now that the yield curve is positive again, does that mean we’re in the clear?
Over the last century, every time the yield curve went negative it was followed by a recession. Not always immediately though. Most conspicuously, the curve was inverted from January 2006 to July 2007 and was well into positive territory by the time the 2008 crisis hit.
Is this a guarantee of troubled times ahead?
Absolutely not. The central banks seem to think we’re all good now and stock markets are testing new record highs, so clearly some traders are content with this sudden recovery narrative.
After all, just because a yield curve inversion has preceded seven out of the last seven recessions doesn’t mean it will happen again.
There’s no doubt that we’re deep into new territory and witnessing an economic condition that’s never happened before.
Prolonged stimulus, artificially suppressed interest rates, and now a significant amount of negative-yielding bonds, this simply has never happened before so it’s kind of hard to know what to expect.
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