Editor’s Note: Pedro Nicolaci da Costa is director of communications at the Economic Policy Institute and a former fellow at the Peterson Institute for International Economics. He has been writing about economics and financial markets since 2001. The opinions expressed in this commentary are his own.
President Donald Trump’s absolute disregard for institutions, international alliances, the truth and basic principles – and his ongoing support among a significant swath of the American population – has the world wondering if the United States is just caught in a temporary fever of newfound autocratic sympathy, or whether this is the start of a potentially more sinister period of political upheaval.
And global markets are reacting. While the Dow and S&P’s daily gyrations steal the headlines, bonds are Wall Street’s sleeping giant. What happens with Treasury notes is often a more relevant indicator of broader economic trends.
Short-term bond yields recently surpassed their longer-term counterparts, a trend that points to an expected decline in financial returns over time and, more alarmingly, has preceded just about every recession since World War II, with around a 1 1/2 year lag. Longer-dated Treasuries offer a higher yield than short-dated ones because investors demand additional compensation for risks taken over a more prolonged timeframe. However, if big banks and investment funds expect the economy to go haywire at some point in the near future, that scenario reverses, giving rise to what markets refer to as a yield curve “inversion.”
But with the economy still growing around 2% at last blush – despite a noticeable slowdown from 2018 – and unemployment remaining below 4%, many experts argue this time is different from past downturns.
Surely, there can’t be a recession around the corner, optimists counter: The economy is still benefiting from last year’s sharp increase in government spending (not from the tax cuts, which have demonstrably failed their stated goal of boosting investment) and the Federal Reserve is now on a permanent pause and even potentially considering cutting interest rates again after two years of hikes.
But what if the bond market’s apparent malaise, the deepest curve inversion since 2007 (remember what happened then?) were signaling something darker and potentially longer lasting than a turn in the business cycle?
Indeed, the yield curve’s alarm bells may be global markets’ awkward attempt to put a price on the rapid loss of an intangible but deeply valuable asset: global trust in the United States as a trading partner and more generally as a leader in the pursuit of democracy and human rights.
Take note of one irony: Yes, the yield curve’s inverted pattern shows a strong appetite for US government bonds when confidence in the country’s political stability is waning. That shouldn’t offer any comfort, however: It’s merely a sign that frightened investors don’t see any other safe investment alternatives to Treasury bonds yet. When Standard & Poor’s downgraded US Treasuries in 2011, for instance, bond prices rallied.
The US-driven trade war, which went from counterproductive to just plain bizarre over the last week, is both a reflection of Trump’s scorched-Earth strategy and a driver of the yield curve’s inversion, because the longer the now multi-pronged conflict lasts, the higher the chances of an economic contraction.
Just as he was purportedly trying to negotiate a cumbersome, wide-ranging deal with China, Trump obliterated whatever smidgen of confidence might be left in his team with a single tweet, threatening new tariffs on Mexico despite a pending trade deal between the US, Mexico and Canada. He then abruptly revoked India’s special trading status with the United States, further confounding the outlook.
The trade wars are arguably hitting Trump’s vaunted base hardest as farmers across the US suffer the brunt of disruptions and poor consumers suddenly face higher prices on key basic goods, ranging from avocados to autos.
And trade is just one of countless policy areas where chaos itself appears to be the strategy. Take Federal Reserve policy, which the bond market tracks so closely. Trump has all but spat on the norms of the central bank’s independence from politics, constantly and erratically bashing former Fed Chair Janet Yellen and then going after his own pick to replace her, Jerome Powell.
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More recently, he sought to nominate two candidates to the Fed’s powerful and influential board of governors who not only lacked the basic qualifications but were also tarnished by harassment and racism scandals. When those two, Herman Cain and Stephen Moore, finally pulled out of the running due to public pressure, Trump reached for Judy Shelton, an economist whose advocacy for a return to commodity-linked currencies is not just anachronistic but would also be deeply destructive.
And these are the light scandals. There’s the constant abuse of democratic institutions and the press. There are the threats to jail political opponents, the juvenile insults, the stomping all over the justice system, the impunity for crimes committed in plain view, the praise for human rights abuses and autocrats. And yet, there remains a solid, ongoing base of support for this president no matter how low he sinks morally and politically.
In short, there’s a global reevaluation of what America really is, what it stands for – and what its changing role in the world means for the future of geopolitical and economic stability.
Those are heavy questions that markets may be ill equipped to handle. Perhaps a little yield curve inversion is just the bond market’s squeamish reaction to America’s vertiginous descent into daily norms that are more consistent with a banana republic-style emerging market than the world’s largest and preeminent economy.