AUSTIN – The stock market crash is – perhaps – the long-awaited signal of a US economic slump. For President Joe Biden’s administration and Kamala Harris’s presidential campaign, the timing could not be worse. For years, they have tried to sell their economic record as a success story. With markets in decline and unemployment rising, that sale just went from hard to impossible.
The market meltdown and impending recession come over two full years after the Federal Reserve started hiking interest rates to “fight inflation.” They are the direct, but delayed, consequence of that policy. So, the Fed’s policy is finally having its intended effect – over two years after inflation peaked and began to fall, for reasons unrelated to the Fed’s policy.
Will a recession now come? For at least 40 years, an inverted yield curve on US Treasuries has been a reliable indicator of recession in America. In 1980, 1982, 1989, 2000, 2006, and 2019, the interest rate on 90-day Treasury-bills rose above that on ten-year bonds, and a slump followed within a year. In all cases after 1982, the inversion was over when the recession arrived – but it arrived nonetheless.
This happens because when the Fed raises short-term interest rates, credit for business investment, construction, and mortgages begins to dry up. Why lend at 4% or 5%, or even more, with risk, when you can park your cash, risk-free, for 5%? Other factors, including a rising dollar (bad for exports), and interest resets on old loans (bad for credit card and mortgage defaults, notoriously in 2007-08), also play a role. Eventually, long-term rates start to rise, and the inversion ends, but then high long-term rates do further damage.
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