U.S. Treasury Bond Yields and Declining Restaurant Labor Personnel: Is a Recession Forthcoming?
By Gavin Davis Managing Principal, H-Fin Capital Advisors | June 16, 2019
Much attention has been recently placed on the inverted U.S. Treasury Yield Curve, where longer-dated U.S. Treasury securities (e.g. Fed Funds Rate approximating 2.50%) express a Yield-to-Maturity lower (i.e. inversion) than shorter-dated U.S. Treasury securities (e.g. 10-year UST under 2.50%), as a harbinger of recession, which in the current environment, we find mostly (but not entirely) misplaced.
If anything, we find yield curve inversions always insightful and worthy of discussion; however, with a propensity for yield curve inversions to be: (a) "early," with significant "risk runaway" before the onset of a recession (if one arrives at all); (b) to be "inconclusive" as a sole data point in their issuance of a statistically significant number of historical false positives as recession tell-tales; and, (c) in the current environment, where U.S. and Global Sovereign Yields are affected by a confluence of new factors (it really is different this time), most prominently amongst those, the substantial and profound effect of the large-scale asset monetization of sovereign debt (and other collateral) by global central banks (e.g. U.S. Federal Reserve, European Central Bank, Bank of Japan) from quantitative easing programs, rendering historic yield curve inversions as less applicable than absent such influential factors in the bond markets.
We, ourselves, still queue on a variety of data when evaluating "recession" risk, and separately timing - sometimes as simple as U.S. Lodging RevPAR growth, which has clearly slowed and remains subdued (no one can argue that either the business cycle or lodging cycle, which have held a historic and studied high correlation, are long in the tooth) - or, as we put forth herein, a somewhat paradoxically novel, simplistic and insightful metric: the monthly change in restaurant labor personnel for full-service restaurants in New York City.
We speak from a position of expert knowledge, experience and recent accurate Federal Reserve interest rate (fed funds) predictions.
By way of background, as part of monitoring the global macro environment and geopolitics in order to provide H-Fin clients with a view into global interest rate markets, as Interest Expense is often the largest expense face by hotel real estate owners, we spend an inordinate amount of time closely monitoring the U.S. Federal Reserve, short term interest rates and risk premia.
Mr. Davis has correctly predicted every single U.S. Federal Reserve Fed Funds decision during the current business cycle, including accurately predicting both the beginning (12 mo in advance) and end of such interest rate cycle (Dec. 2018). (for our forecasting track record see a recap of our recent commentary on our April 1, 2019 blog post.
In November 2018, we were the first entity (that we are aware) to definitively call an end to the Federal Reserve's rate hike cycle; and, also indicating that there would be no additional rate cuts in 2019. In April 2019, we have indicated that the Federal Reserve, once Quantitative Tightening (QT) is concluded in September 2019, and a static level of excess reserves being maintained in the system - now dubbed, a Treasury Repo Facility by the St. Louis Federal Reserve, and likely to make its way into the financial vernacular in time as such, in maintaining such a Repo Facility, may just as likely should economic weakness appear or deflation begin to seemingly take hold, move for monetary policy to maintain an active band around the constant level of Excess Reserves, with the ability to trim Excess Reserves on a monthly basis by the FOMC in (QT) and out (QE).
Peak Excess Reserve levels were $2.8 Trillion (Oct-14) and $2.2 Trillion (non-reinvestment of maturities) when QT started in October 2017. The level of Excess Reserves at the conclusion of QT (Sep-19) is estimated at $1 Trillion. There is discussion of the Federal Reserve maintaining up to $200 billion of additional reserves as a "buffer" to active manage of this new repo facility. We believe that active management of the facility at FOMC meetings may not be overly cumbersome or problematic, and once QT is definitively stopped in September 2019, the Fed may likely add the ability to flex the Repo Facility to-and-fro (i.e. QE or QT) within a range of up to 20% either direction of its standing facility.
Not to digress to far-a-field, but to provide additional background on certain of the technical nuances that do actually make this time different (it's a new policy tool, and a formidable one), knowing that the Yield Curve did in fact invert (and twist) earlier this year, we return to in instances of yield curve inversion being a harbinger of future economic recession, how "early" is this indicator. According to Charlie Bilello, of Pension Partners, "yield curve [inversion] is a long leading indicator, and in the last 3 cycles it took between 16 and 31 months after 5-yr/6-month inversion for a recession to start and between 16 and 22 months for the stock market to ultimately peak."
Also, as we mentioned, yield curve inversions can and have had a number of false positives resulting in no onset of recession. According to Economic Cycle Research Institute (ECRI), in Behind the (Yield) Curve: Assessing the Recession "Predictor", in revisiting yield curve inversions and recession in 2005, basing their analysis on "the most widely researched and discussed yield curve definition, i.e., the difference between yields on ten-year and three-month government securities" in five key advanced economies - the U.S., the U.K., Japan, Germany and France (ICO, August 2005). [They] concluded that inverted yield curves correctly predicted just over 60% of recessions, and that "[i]n the U.S. and U.K., they also issued false alarms … 38% of the time yield curve inversions took place."
We regularly follow ECRI's publicly available indices for our own elucidation and incorporation into our views. ECRI's WLIW, a U.S. Weekly Leading Index, has been trending up for several weeks now and is back in positive territory (as we often and timely relay to our subscribers, on our blog and to our clients, in the context of our market views)
Based on the aforementioned three factors: a confluence of new factors influencing global sovereign bond yields (e.g see Italian bond yields backstopped by the ECB and IMF relative to U.S. sovereign yields); false positives of an inverted yield curve, and the proclivity for an inverted yield curve to arrive well before risk markets have peaked, it remains but one of our own data points (certainly worth monitoring) of pending recession risk.
The Federal Reserve has its own indicators, two of which are: (1) Smoothed U.S. Recession Probabilities Index, which is a dynamic-factor markov-switching model applied to four monthly coincident variables: non-farm payroll employment, the index of industrial production, real personal income excluding transfer payments, and real manufacturing and trade sales. (This model was originally developed in Chauvet, M., "An Economic Characterization of Business Cycle Dynamics with Factor Structure and Regime Switching, " International Economic Review, 1998, 39, 969-996, and, (2) a GDP-based Recession Indicator Index that measures the probability that the U.S. economy was in a recession during the indicated quarter. It is based on a mathematical description of the way that recessions differ from expansions.
The index corresponds to the probability (measured in percent) that the underlying true economic regime is one of recession based on the available data. Whereas the NBER business cycle dates are based on a subjective assessment of a variety of indicators that may not be released until several years after the event, this index is entirely mechanical, is based solely on currently available GDP data and is reported every quarter. Due to the possibility of data revisions and the challenges in accurately identifying the business cycle phase, the index is calculated for the quarter just preceding the most recently available GDP numbers.
Once the index is calculated for that quarter, it is never subsequently revised. The value at every date was inferred using only data that were available one quarter after that date and as those data were reported at the time. If the value of the index rises above 67% that is a historically reliable indicator that the economy has entered a recession. Once this threshold has been passed, if it falls below 33% that is a reliable indicator that the recession is over.
As an example of other proxies, we present the U.S. Bureau of Labor Statistics All Employees in Full-service restaurants index for New York City and overlay it against the aforementioned two Federal Reserve Recession indices, which can and does act as a prescient tell-tale not to be dismissed, in the chart above.
In doing so, we observe that in the Second Quarter of 2001 as the U.S. economy was headed towards recession, the Smoothed U.S. Recession Probability index had a reading of 33.66; the GDP-based Recession indicator index has a reading of 58.22; and, the NYC Restaurant Personnel index was declining with a reading of +2.6%. In the Third Quarter of 2001, the Smoothed U.S. Recession Probability index had a reading of 32.72, GDP-based Recession indicator index 83.83 (now recessionary), NYC Restaurant Personnel index was still declining with a reading of +2.6%, reaching a -6.0% in December 2001 (a level it had also seen when the index was first established in the early 90s and the previous recession).
In the last recession, the Great Recession, in the Second Quarter of 2008, the Smooth U.S. Recession Probability Index had a reading of 75.32, the GDP-based Recession indicator index has a reading of 46.10, and NYC Restaurant Personnel index was +5.98%. By December 2008, the NYC Restaurant Personnel index was +1.58%, falling to -1.10% in February 2009. Therefore, from the evidence presented (without having run any regression or a correlation coefficient, this proxy appears highly correlated to U.S. Recessions).
In January 2018, the NYC Restaurant Personnel index read 0.50%, with the Recession indices not evidencing much rising risk of recession. Since May 2018, the NYC Restaurant Personnel index, continuing its decline has remained in negative territory; however, the Recession indices continue to not indicate a rising risk of recession (at the same time that the yield curve has recently inverted). Therefore, what could this trend and decline be telling us? Well, it could be correlated to the decline in residential sales volumes and sales prices in New York City and the Hamptons.
It could be the "GrubHub" effect (note: GrubHub's "Daily Average Grub Growth," "Gross Food Sales Growth," "Active Diners" and "Revenue" have all begun to slow for the latest quarter (4Q18)) and displacement of full-time restaurant workers. Irrespective, we make our point, we present a strong simplest proxy for recessions (of the many one could select and should review) appearing to be highly correlated with the prior three recessions, that we will continue to monitor going forward.
Currently the labor market remains far too robust for the entirely the U.S. economy, itself impacted by slowing global demand and growth, to be derailed, ceteris paribus. However, according to data from FactSet, S&P500 earnings are expected to decline 3.4% in Q1, marking the first contraction in nearly three years, and following five consecutive quarters of double-digit growth. S&P500 companies that generate more than half of their sales outside of the U.S. are expected to size a decline of 11.2% (as averaged).
Should companies begin to look to managing personnel via layoffs, then this would be one of the first signs we would look to in revisting this metric, perhaps more formally testing such empirically and looking to other cities, or an aggregate of such metrics as a leading indicator to U.S. economic recessions.
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