Today we want to take you on a brief trek through some economic and capital market “extremes”. Given the avalanche of data we all have to contend with every day, there is comfort in averages and indices, mean observations and consensus. At the same time, there is much to learn from looking at datapoints located far outside our comfort zone. Travel expands the mind, the saying goes, so let’s start the journey…
Take as one example the spread between 3 Month and 30 Year US Treasuries – the bookends of the world’s risk free yield curve. Here’s where they stand at the moment:
- 3 month Treasuries yield 1.94%
- 30 year Treasuries yield 3.12%
- Net difference: 118 basis points
While we (and most others) typically look at the spread between 2 Year and 10 Year Treasuries to measure the steepness of the yield curve, this 3 Month/30 Year comparison tells a sharper story at this point in the cycle.The 3-month bill only captures near term Fed policy, rather than the 2 Year’s guesstimate of the same. On the other end of the curve, 30 Year bonds trade primarily on structural views of inflation across multiple business cycles instead of just one or two.
What this “Extreme Indicator” is saying: stop worrying about a US recession in 2019. That’s not too much of an exaggeration, actually. Looking back at the data to 1977 , the warning sign is when 3-month Treasuries yield more than 30 years. At a +100 basis point spread, we have a ways to go and at current trends this will not happen for +12 months.
Now, we would be remiss in implying there’s a free lunch here; there isn’t, because 3-Month Treasury yields play into US commercial paper borrowing costs. Here’s the issue:
- 30 day non-financial company commercial paper (rated AA) now costs companies 1.87% on an annualized basis. That’s essentially double the rates of last year at this time (0.93%).
- 3 month AA commercial paper issued by a financial company now costs 2.19%, up from 1.06% this time last year.
Now, I’m going to bet most readers don’t look at the CP market too often so we’ll lump it into our “Extreme” classification. The good news here: CP outstanding is just over $1.1 trillion at the moment, down by half from pre-Crisis levels. The bad news: it costs both industrial and financial companies twice as much to fund their day-to-day operations than a year ago.
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Another “Extreme” example in economic analysis: the relative levels of unemployment between US states as compared to countries in the Eurozone, looking at just the highest and lowest. Here’s the April 2018 data:
For the US:
- 3 states with lowest unemployment: Hawaii (2.0%), New Hampshire (2.6%) and North Dakota (2.6%). Average of 2.4%.
- 3 states with highest unemployment: Alaska (7.3%), DC (5.6%) and West Virginia (5.4%). Average of 6.1%.
For Europe:
- 3 Countries with the highest unemployment rate: Greece (20.8%), Spain (15.9%), and Italy (11.2%). Average of 16.0%.
- 3 countries with the lowest unemployment rate: Czech Republic (2.2%), Malta (3.0%), and Germany (3.4%). Average of 2.9%.
The ratio between US states is 2.5x worst-to-best; for the Eurozone it is 5.5x. Also worth noting: the American outliers are all small states. In Europe, they include 3 of the 5 largest countries (Spain, Germany and Italy).
The conclusion is both obvious and difficult: the economic “recovery” in the Eurozone has been profoundly uneven and has a long way to go before it reaches Italy and Spain. Trillions of euros in ECB bond buying have not fixed the deep structural divide between north and south. The next recession, whenever it comes, will be very hard on the European project.
Let’s move on to another “Extreme” take on US unemployment, categorized by educational attainment. The data from last week’s Jobs Report:
- Workers WITHOUT a 4 year college degree: 3.8% unemployment, 59% participation rate.
- Workers WITH a 4 year college degree: 2.0% unemployment rate, 74% participation rate.
- Note: the US workforce is mostly (60%) comprised of people without a 4-year college degree.
To us, this tells the story of the US economy more accurately than any other single cluster of statistics. Essentially, there are two American labor markets. Fully 3 in 4 people who have a 4-year college degree are in the workforce, and 98% of them have jobs. By contrast, barely more than half the population without a 4-year degree are in the workforce. Thanks to a good economy, however, 96% have employment.
The purpose of this exercise was to travel through some less-visited data, but let’s return home now with 2 conclusions:
- The 3-month/30 Year Treasury curve confirms what more traditional (2s to 10s) measures are saying: the next recession still sits over the horizon. At the same time, it reminds us that money isn’t free anymore (the point about commercial paper).
We don’t hear anyone talking about this, but with $1.0 trillion of CP outstanding we suspect it’s only a matter of time before we do.
- Aggregate employment data is very misleading. In the US, it misses the “Two labor market” message of college/no college. In Europe, the disparity between Germany and Italy/Spain remains a powerful political problem.
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