- Leading economic indicators, such as the inverted yield curve, have warned that a recession is imminent.
- But these gauges are misleading amid strength in credit conditions, Ed Yardeni wrote on Monday.
- The Fed's own quantitative tightening program may also be skewing the yield curve, he said.
While the recent market shake-up has cracked Wall Street's faith in the US economy, the onslaught of recessionary alarms is creating a false sense of worry, Ed Yardeni wrote on Monday.
He noted that although reputed indicators are flashing red, such as the inverted yield curve or unemployment-tracking Sahm Rule, conditions necessary to trigger a recession remain absent.
Fresh anxiety might also spring from the fact that the yield curve is finally disinverting, which is a recessionary signal on its own.
When long-dated Treasury yields climb above short-term ones, it hints at expectations that the Federal Reserve will have to cut interest rates rapidly, often pressured by a looming credit crisis.
But Yardeni sees no such risk in today's cycle:
First, consider that credit conditions have held up against the Federal Reserve's tighter interest rates.
Yardeni, citing the Fed's Senior Loan Officer Opinion Survey, noted that conditions have actually loosened: Fewer dealers have constricted lending standards this year, and Yardeni expects a broad loosening next quarter.
"Credit crunches don't tend to happen unless a crisis causes lenders to pull back and freezes the availability of financing, even for highly rated borrowers," Yardeni said. "In other words, the Credit Crisis Cycle may be on pause this time."
Stable credit conditions also contradict a typical reason for why the yield curve inverted in the first place.
Commonly, when short-term rates jump above those of long-dated bonds, it signals that investors expect a credit crisis to roil the short-term assets. They are usually correct, Yardeni noted, but not this time around.
"That's what happened in almost all previous Fed tightening cycles. It's no surprise that the 2-year to 10-year yield curve reached -107bps, one of its most extreme inversions of this tightening cycle, on March 8, 2023 just as Silicon Valley Bank was failing," Yardeni wrote.
And yet, the market's panic proved brief during SVB's downfall, as the Fed stepped in rapidly to insure all depositors.
Secondly, credit spreads have not reached levels that suggest a brewing crisis, Yardeni said. When this measure rises, it can signal deteriorating economic conditions.
But even last week's seismic, albeit temporary, meltdown in equities didn't really change things too much: according to the ICE BofA US High Yield Index Option-Adjusted Spread, the gauge remained well below highs notched since 2022.
Thirdly, part of the reason for the yield curve's behavior is the Fed's own stock of Treasurys, Yardeni said: essentially, a larger percentage of the central bank's holdings are made up of long-term bonds.
That's due to the Fed's own quantitative tightening program, in which the bank allows assets to roll off its balance sheet without reinvesting them into the economy.
But when this happens, shorter-term Treasurys typically roll off quicker than longer ones, Yardeni noted. Meanwhile, he added that the heavy issuance of short-dated T-bills has also helped offset market appetite for long-term bonds.
Yardeni has long remained resolute in the market's bullish potential, often touting that assets are rocketing toward a "Roaring 2020s" scenario.
He extended this line of argument in Monday's note, highlighting the lack of recession signals in the latest earnings report season. S&P 500 earnings-per-share collectively rose 10.9% year-over-year last quarter, he said, hitting a record of $60.19.
"If the no-show recession continues not to show up, S&P 500 forward EPS should continue to be a bullish leading indicator for actual EPS as well as for the economy," Yardeni wrote.