First Trust economist dismisses fears of recession induced by low yields

First Trust economist dismisses fears of recession induced by low yields

First Trust economist dismisses fears of recession induced by low yields In a video commentary posted on the website of First Trust Portfolios Canada, Chief Economist Brian Wesbury explains that while many investors fear a possible inversion of the US yield curve that would signal a recession, their thinking is founded on a flawed premise.

“Lots of people are worried that when the Fed raises rates, long rates either won’t go up or might go down further and will invert the yield curve, and that will signal a recession. I don’t believe this; I think this is the wrong way to look at interest rates around the world,” Wesbury says in the video.

The economist asserts in the commentary that looking at low interest rates as points toward which other bond yields will fall is incorrect. “That’s a mistake because we’re looking at actual interest rates,” he says, explaining that to compare interest rates fairly, nominal GDP has to be taken into account. According to him, the gap between nominal interest rates and nominal GDP should be the basis on which credit risk is evaluated.

“You have to look at things in a relative sense. In other words, when you land at Boise, Idaho in the airport, you land at 2,800 feet [above sea level]… In Chicago when you land, you’re landing at close to 400 or 500 feet. If you try to land at the same altitude in Boise as you do Chicago, you crash.”

To drive home his point, Wesbury cites key statistics for different countries. According to him, Germany’s nominal GDP is at 1.6% and its nominal interest rate is at 0%, making a gap of -1.6%. Japan has a nominal GDP of 0% and an interest rate of -0.2%, putting the differential at -0.2%. For Canada, the interest rate is 1.9% below nominal GDP. “That makes sense because of those three countries, we are the best credit risk, [and] Germany is clearly a better credit risk than Japan.”

Wesbury concludes: “This idea that the US is going to see drops in long-term interest rates because other interest rates are lower misses this point: interest rates are determined on a relative basis, not an actual [absolute] basis. And that is why I believe as the Fed lifts interest rates in the US, long-term interest rates will go up as well, and the yield curve will not invert. In other words, do not look for a recession from Fed tightening anytime soon.”

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