This month something happened that has not happened since 2007 – the US yield a curve inverted. To the vast majority, that term means nothing but historically it has had a massive impact on people’s lives.
Simply put, if you were to chart the interest rate that bonds pay at different maturities (years until you get paid), and then connect those dots, you would get a curve that normally moves up and to the right. That makes a lot of sense because it shows that the longer you lend money for the more interest you would receive. An inverted yield curve means that long term interest rates are now lower than short term interest rates. So why would this happen? Why would people be willing to lend for 5 years for less than they would get on a 1-year loan? There is one answer, that borrowers expect interest rates to fall over that time. And what would cause this? A recession. Invested yield curves do not guarantee a recession, but over the last 50 years, they have happened before every single recession. While there are no guarantees the pattern will be followed here, an indicator with a 100% accuracy rate is something to inspire fear.
So why is this happening now? Recessions are a natural part of economic cycles and it has been a long time since we have had one. In fact, it has been 11 years, making this the longest economic expansion we have ever seen without a recession. So quite honestly, we are due. When you look around at the world today, you start to see signs everywhere that the politicians we have put in place seem hell-bent on driving us into a recession for their own ideological reasons.
Perhaps the most dramatic case is the United Kingdom and the never-ending drama that is Brexit. Despite the fact that polls since the initial vote have shown that Brexit supporters are in the minority, their economy has suffered, companies have moved their head offices overseas, and every economist denounces this move, because Boris Johnson is hell-bent on leaving the EU. The ramifications of leaving without a deal would be devastating. Parliament’s own report predicts widespread food, fuel and medicine shortages within days and border chaos that will cripple the country. They literally expect people to die from lack of access to insulin and other drugs if a no-deal happens, but Boris seems okay with that. Shockwaves of this move would be felt anywhere, including here in Canada as the UK is our third-largest trading partner, buying almost 3% of our exports.
In the US, President Trump has managed to survive three years in office without being able to grasp that tariffs are not paid for by the countries that manufacture goods, but the American consumer who buys those goods. Heading into the next elections he is only upgoing his anti-China rhetoric and has been continuing to increase tariffs at every opportunity. This coupled with slowing growth, does not make for a positive combination. While a UK recession would hurt us, US recessions are particularly painful as they are the market for 78% of our exports. Even a small change in that number has serious implications for Canada.
Couple the US and UK situation with an economic slowdown in China and turbulence in the middle seat, and there is a reason for concern almost anywhere you look outside of Canada.
As for our situation domestically, there is a lot to be concerned with at home. The economy, and correspondingly the job picture, has been moving at a slow crawl. Couple that with an all-time record high personal debt levels, and a real estate market that is so overheated that every major international economic associations has warned Canada that the situation has gotten out of control, and the only conclusion is that we are in a sensitive position right now. To top it all off it is an election year, and despite the fact that we are not in recession yet, the ruling party is promising to cut cheques to almost every cause imaginable and has shown little to no interest in balancing the budget. Keeping those promises and trying to stimulate the economy if there is a downturn will lead to deficits that could take a long time to crawl out of.
Overall, looking around the world at the economy in the future, the picture is not looking great, however, there is one wild card. In the recent decade, central banks around the world have coordinated their efforts like never before. Their role was previously seen as being a sound steward of the economy, tasked with not letting things get too bad or too overheated. But in the most recent decade, due in part to the size of the 2008 crisis and many government’s lack of willpower to handle their budgets soundly, they have more and more been playing the role of keeping the party going. While this is beneficial to all of us in the near term, it bears the risk of making future blow ups worse. Should central banks move quickly in the next few months they could end up finding ways to stimulate the economy and kick the can down the road. Frankly, no one knows what the end result will be.
So, what is one to do? The answer is the same in every economic situation: prudence. Your portfolios should be diversified and exposing you to no more risk than you can tolerate, debt levels should be at levels that give you lots of breathing room and should have a cushion in case of emergency. For those who are not in that situation, the best thing you can do for yourself, both short and long term, is to do what you can to put yourself in a prudent situation as soon as you can.