Yield Curve Inverts, But Incipient Signs That Worst of the Slowdown is Behind Us

The markets finally appear to be reacting to the global economic slowdown.  Both the stock and Treasury markets had large moves in response to the drop in the German Market Purchasing Managers Index.  In particular, the 10-year/3-month Treasury yield spread turned negative -- the first time this curve "inverted" since 2006.  Some commentators have highlighted the conventional view that an inverted yield curve typically precedes a recession. 

The conventional view may be too dire now.  The globalization of the financial markets may have made US markets more sensitive to European and Asian economies than in the past.  Investment flows move quickly across borders to "capture" yield.  The decline in the German bond yield to a negative level last week likely prompted a shift out of them into Treasuries.  Even without considering the effects of globalization, history shows the lead time from the start of an inverted Treasury yield curve and  recession to have been mostly over one year:

                                                   Starting Month
                 10-year/3-month Tsy Yield Curve                Recession             Lead Time            
                          Inversion                                                                 (# of months)
                          June 89                                                   Jul 90                    13
                          Jul 00                                                    Mar 01                     8
                         Mul 06                                                   Dec 07                   18

Ironically, evidence is beginning to creep in suggesting the worst of the US economic slowdown may be behind us.  Both Initial and Continuing Claims are below their recent peaks, the March Phil Fed Mfg Index turned positive, and February Existing Home Sales rebounded sharply.
To be sure, some of the factors behind the US slowdown -- bad weather, weak export demand, year-end Fed tightening -- still can exert downward pressure on the economy, and it may not be until well into the Spring to get a clearer picture of faster growth.  So, stocks are still vulnerable for a further pullback, particularly with Q119 corporate earnings soon to be reported.  And, longer-term Treasury yields could fall by more, further inverting the curve. 

But, the markets may find themselves to have overshot later this Spring.  Both the ECRI Leading Index and the Atlanta Fed Model forecast have strengthened, suggesting this possibility.

The ECRI Leading Index hints that the worst of the US economic slowdown is behind us (see chart below).  The Index has risen in each of the latest 5 weeks (from the February 8 week to March 15 week), albeit modestly.  This is its longest stretch of gains since October 2017.  It will be of interest if it does not turn down in next week's report, which covers the week when stocks declined and the yield curve inverted.  If it does decline, the question will be whether it more than unwinds the recent move up.  If not, the uptrend may still be in place.

The Atlanta Fed model boosted its projection of Q119 Real GDP Growth to 1.2% from 0.4% on Friday, thanks to the large gains in Existing Home Sales and Wholesale Inventories reported last week.  It is too soon to consider this a reliable forecast, however.  And, some of the GDP component estimates could be too low.  But, if the model stays near its current estimate, a speedup to about 3.0% GDP Growth in Q219 would be needed to bring H119 Growth in line with the Fed's 1.9-2.2% Central Tendency for the year. 

ECRI Leading Index (level)