Many are starting to believe that the yield curve is a false positive for a recession and that good times are just around the corner.
The length of time the yield curve is inverted and the severity of the inversion are also important. Historically when one is long and the other is deep, the recession that follows is deeper.
Maturing debt can skip over inversion and consumer spending stretched despite it for a while but time is not on their side. Like Napoleon said once “Strategy is the art of making use of time and space. I am less concerned about the latter than the former. Space we can recover, lost time never.”
We have given up little space to inversion (demand is still strong and delinquency rates low) but a lot of time has been eaten away.
Time is an important element. Time has eaten away savings, started to shrink earnings and margins, and started to increase debt payments as a share of earnings and incomes. Time is the enemy.
As companies get hit with higher debt interest payments (inventories financed at the short end) they will start cutting their inventories versus accumulating them. They will start ordering less and only when needed as demand weakens. That starts slashing new orders. Those new orders not coming in will weigh heavily on producer’s labor planning. As employees get hours slashed or worse are laid off they spend less.
As earnings and margins continue to fall, debt to income ratios get worse. Money starts running out quicker. Also, a lot of this debt will start maturing. 3 years after the pandemic, recent ultra-low rate debt (some of that included previous debt that was rolled over) will start maturing. Again time is not on their side.
The longer it goes the worse the economic situation. We are bleeding resources accumulated during the pandemic (liquidity and savings) trying to keep space. Corporations and consumers are getting exhausted and the thin front line they are holding can collapse and a rout could ensue.
We might be at the gates of Moscow but Winter is almost here and it’s a long road back to Paris.
