Recession Imminent Due to Liquidity Problem?

Federal Reserve Chairman Powell
Federal Reserve Chairman Jerome Powell

UPDATE: Since this original post, the Fed has now pumped more than $1T into the banking Repo markets and there is no end in sight.

Fed Chairman Powell today indicated the US was not heading into a recession and said the economy is doing quite well. Consumer spending is up, housing starts are good. But in the same breath indicated the Fed was again cutting its lending rate by a quarter of a percentage point. Seems rather contradictory considering the Fed cuts its rate when it needs to spur the economy to prevent the very thing he said we’re not heading towards. Moreover, it appears they are ready for one more cut before the end of the year (UPDATE: The Fed in fact cut another .25 basis points).

At the same time, and for the third day in a row, the Fed injected another $75 billion of liquidity into the money markets because there wasn’t enough short-term cash for the banks and hedge funds to fund their trading operations. Because of this, the interest rate skyrocketed from 2.25% to 10% overnight Monday, Tuesday and now Wednesday. Chairman Powell again seemed to brush it off as if it were not big deal. Only, this is the first time the Fed has had to inject liquidity into the markets in over a decade, just before the last recession took hold in the US (e.g.; Financial Crisis of 2007).

Manufacturing PMI

To make matters worse, the United States Manufacturing PMI continues to slide, where a reading of less than 50 indicates contraction in that particular sector. The latest reading pointed to the weakest pace of expansion in the manufacturing sector since September 2009.

To top off the bad news, the spread between the US 10-year (considered the worlds safest treasury) and US 3-month treasury has sustained its inversion a full quarter as of this blog entry. That is to say, short term rates are higher than long term rates (inverted yield curve).

On average, a recession last about 18 months. If investors believe a recession is imminent, they’ll want to put their money in a safe investment for at least two years to outlast the 18-month average recession length. They’ll avoid short-term Treasuries with maturities of less than two years. That sends the demand for those bills down, sending their yields up, and inverting the curve. An inverted yield curve has preceded the recessions of 1981, 1991, 2001, and 2008.

Another thing I find alarming is FedEx had a horrible quarter, which resulted in the stock price dropping 12.95% in one day. That’s the worst drop it has seen since 2008. This is important because FedEx is an indicator of consumer spending. The company also gave a poor forward looking guidance because it sees domestic and international economic conditions deteriorating.

Elsewhere in the world:

  • New Zealand annual GDP growth hit a 22-month low.
  • Germany has negative yields as does Denmark.
  • Hong Kong just cut its rate by 0.25% percentage point
  • Brazil cut its rate by 0.50% percentage point
  • Australian jobless rate is at its highest in over a year
  • Japan leaves its short term rate unchanged at -0.1% and its long-term rate at 0%.

This doesn’t sound like a healthy economy … and does anyone really think the Fed Chairman would come out and say the US is heading into a recession? Of course not. Even suggesting such a thing would crash markets in the US and around the world.