How the Fed Could Be Telegraphing a Recession

Summary

---

WSJ Your Money Briefing — "How the Fed Could Be Telegraphing a Recession"

Date: June 12, 2018
Host: J.R. Whalen
Guest: Justin Lehar, "Heard on the Street" columnist, Wall Street Journal

---

Episode Overview

This episode explores whether the Federal Reserve’s projected interest rate hikes could inadvertently signal an impending recession. Host J.R. Whalen and columnist Justin Lehar break down what happens when short-term interest rates rise above long-term rates—a phenomenon known as an inverted yield curve—and discuss its historical significance, current context, and implications for the broader economy.

---

Key Discussion Points & Insights

1. The Fed’s Current Position and Expectations

• The Federal Reserve began a two-day meeting, expected to announce a quarter-point rate hike.
• The Fed initially anticipated a cooler economy in 2018 but found unemployment and inflation hotter than expected.
  • Unemployment is at 3.8%—lower than the Fed predicted for the end of the year.
  • Inflation is running higher than expectations.
• As a result, the Fed may raise rates more aggressively, possibly up to four times in 2018.

Quote [02:17] — Justin Lehar:

"They thought that the economy was going to be cooler this year than it seems like it is... Inflation is running a little bit warmer too. So they're going to be lifting rates a little bit more aggressively than what they thought."

---

2. Yield Curve Inversion and Recession Signals

• When short-term rates (e.g., 2-year Treasury) move above long-term rates (e.g., 10-year Treasury), it’s called a "yield curve inversion," often viewed as a recession signal.
• This has preceded major downturns, including the 2007–2008 Great Recession and the 2001 recession.

Quote [03:17] — J.R. Whalen:

"Last time the yield curve inverted like when the short term rates inched higher than the long term rates, we were on a path to the Great Recession."

Quote [03:32] — Justin Lehar:

"People also at that time... said, 'it doesn't really count.' Well, it started inverted in 2006 and it was still inverted in 2007. And then a recession happened. So again, it seemed like it was right."

---

3. Is This Time Different?

• Market participants and central bankers claim current conditions are unprecedented due to:
  • Ongoing bond-buying by the Fed and other central banks, holding down long-term rates.
  • An unusually large Fed balance sheet.
• Some argue these factors make the yield curve inversion’s predictive track record less relevant.
• However, past economic cycles have also heard claims of “it’s different this time”—often right before a recession.

Quote [04:02] — Justin Lehar:

"Central banks bought a ton of bonds... that's affecting long term rates and pushing them lower than where they would be otherwise. So therefore it won't really count. Okay, but again, we heard people say, oh, it doesn't really count before."

---

4. Why the Fed Can’t Ignore the Fundamentals

• The Fed’s job is to prevent overheating when unemployment is low and wages rise, even if it risks inverting the yield curve.
• The yield curve doesn't "cause" recessions per se; it reflects underlying economic expectations—when rates invert, markets are signaling that current policy is too “tight” for future economic growth.

Quote [05:36] — Justin Lehar:

"If the short term rates go higher, it means that... they’re sort of saying that they're going to be higher than normal, which is another way of saying that the Fed is kind of ratcheting down on the economy, trying to cool the economy down."

• Letting the economy “run hot” to avoid a yield curve inversion can be dangerous; the Fed must balance inflation, wage growth, and economic momentum.

Quote [06:52] — Justin Lehar:

"It seems fairly accommodative—rates are still pretty low. So they probably feel like they have some room to go and... right now we have a 3.8 [percent] unemployment rate. It seems okay with wages... maybe at the end of the year you're at 3.2. And that's kind of, you know, sort of an amazing place to be... again, we want, we kind of want wages to go up."

---

Notable Quotes & Memorable Moments (with Timestamps)

• On history repeating itself:

  • Justin Lehar: "It was also we saw the same thing happen in 2000. So again, this time if it happens, people will say, well, this time's different." [03:36]

• Lighthearted moment on jargon:

  • Justin Lehar: “And I said it again. Yield curve. Invert so much jargon on top of..." [05:10]
  • J.R. Whalen (clarifying): "...for folks like my parents who don't know what that means, but they can envision short term rates going higher than long term rates." [05:15]

• On the inevitability of economic cycles:

  • J.R. Whalen: "It just seems like the numbers don't lie and the path of the rates don't lie and lightning can strike twice in the same place." [04:35]
  • Justin Lehar: "Yeah. Or over and over and over and over again when it comes to this thing." [04:45]

---

Important Segment Timestamps

• Fed projections & current economic snapshot: [02:17–03:17]
• Yield curve inversion history & market psychology: [03:17–04:35]
• Debating “this time is different” & Fed’s balance sheet: [04:02–05:36]
• Explaining yield curve mechanics to all listeners: [05:10–05:36]
• Fed’s policy balancing act (unemployment, wages, inflation): [06:30–07:39]

---

Tone and Language

• The episode maintains a conversational yet insightful tone, balancing plain language with necessary financial terminology. The hosts make an active effort to clarify jargon and explain concepts for both expert audiences and laypeople.

---

Summary Takeaway

The podcast contends that while the Federal Reserve must continue to raise rates to manage inflation and a hot labor market, doing so risks inverting the yield curve—a persistent, if controversial, indicator of future recession. Despite arguments that today’s unique economic conditions might make such signals less reliable, history shows that ignoring them could be dangerous. The episode ends with a call for ongoing vigilance and critical scrutiny of both market indicators and policy actions.

---

Transcript

[Advertisement Voice]

Still running global payroll like a relay race. Deal replaces fragmented payroll vendors with one global system. No third parties hire, manage and pay teams in 150 plus countries with in house local experts and white glove delivery and deal plugs into what you already use. Workday SAP, Netsuite operate like a local everywhere. Visit d e l.com WSJ that's d e e l.com WSJ your money briefing

[J.R. Whalen]

Money and market stories from the Wall street journal. I'm J.R. whalen in New York. The Federal Reserve projects three or maybe four interest rate increases for the year, but could the Fed be also telegraphing that the country is moving closer to recession? We'll discuss in a moment. First these money headlines. We're entering a period where you can expect lower stock market returns. That's the word from a Morgan Stanley research note. The note indicates that while dividend payments globally tend to be biggest in April and May as compared with all other months of the year, June has seen historically the lowest occurrence of positive returns, while August traditionally is the year's second lowest month. And the Wall Street Journal's CFO Journal team says that businesses across the US Are paying more attention to state taxes which have become a larger share of their total tax liability under the new tax law. Now, now, while the federal corporate tax rate fell to 21% from 35% under the federal tax overhaul, state tax rates remained unchanged. Many states are expected to lower their corporate tax rates in line with the federal reduction as a way to project a business friendly environment. This is your Money briefing from the Wall Street Journal. Welcome back everybody. The Federal Reserve kicks off a two day meeting Tuesday and the central bank is widely expected to announce a quarter point interest rate increase on on Wednesday. Hurt on the street columnist Justin Lehar joins us to discuss whether the Fed is walking a tightrope in the risk it runs of setting off recession fears. So Justin, the concern you raise in your Wall Street Journal column is that if the Fed projects four rate hikes this year, that could move potentially short term rates higher than long term rates and that could set off alarms.

[Justin Lehar]

Yeah. So it wouldn't happen right away, but just where the Fed is going right now, they thought that the economy was going to be cooler this year than it seems like it is. They said at the end of the year the unemployment rate would slip to 3.8% and we're already at 3.8%. Inflation is running a little bit warmer too. So they're going to be lifting rates a little bit more aggressively than what they Thought what that means, what that should mean is that short term rates, and here we're going to say the two year rate is going to, it should be moving higher over the next several months. Right. And then this other question is, you know, well, what does that do with the 10 year rate? Well, the 10 year rate has been sort of stuck and the 2 year rate has been going up and people get concerned when the two year rate goes above the ten year rate. That's what's called the yield curve inversion. We're not going to say yield curve anymore after this. But when that happens, that is often a signal of an upcoming recession.

[J.R. Whalen]

Well, you know, many on Wall street have seen this movie before. In fact, in 2007 those fears became reality. Last time the yield curve inverted like when the short term rates inched higher than the long term rates. We were on a path to the Great Recession.

[Justin Lehar]

Right. And people also at that time, people said, oh, there's no signal here. It's different this time. They said that it's different this time. There's not going to be a recession. Well, it started inverted in 2006 and it was still inverted in 2007. And then a recession happened. So again, it seemed like it was right. And it was also we saw the same thing happen in 2000. So again, this time if it happens, people will say, well, this time's different.

[J.R. Whalen]

You pointed out in your story. They're saying exactly that.

[Justin Lehar]

Yeah. And you can understand why they can say, well, hey, central banks bought a ton of bonds. Some central banks are still buying bonds. The Fed still has a huge balance sheet of all these bonds that it bought in response to the financial crisis and that is affecting long term rates and pushing them lower than where they would be otherwise. So therefore it won't really count. Okay, but again, we heard people say, oh, it doesn't really count before. So it's going to make people a little leery if it happens.

[J.R. Whalen]

It just seems like the numbers don't lie and the path of the rates don't lie and lightning can strike twice in the same place.

[Justin Lehar]

Yeah. Or over and over and over and over again when it comes to this thing.

[J.R. Whalen]

You raise a good point in your column also about the Fed's thinking and how it can't be gun shy about raising rates just by reacting to the path of the yield curve. There are some other factors.

[Justin Lehar]

Right. Well, one of the things is, well, why did. Right. It's not that the yield curve inverting was necessarily what caused the problem. A lot of times the reason And I said it again. Yield curve. Invert so much jargon on top of

[J.R. Whalen]

we are making it clear to people that that's when the short term rate then goes higher than the long term rate. For all of the academics out there, financial academics, we hear you. We are here for you. Yield curve. For folks like my parents who don't know what that means, but they can envision short term rates going higher than long term rates. There you go. So we're here for everybody.

[Justin Lehar]

Okay? So let's just think about what that means. What it means is if the short term rates go higher, it means that, well, people in the treasury market think that overnight rates are going to be higher over the next two years than they will average over the next 10 years. Right. They're sort of saying that they're going to be higher than normal, which is another way of saying that the Fed is kind of ratcheting down on the economy, trying to cool the economy down. Well, sometimes the Fed really needs to cool the economy down. Sometimes inflation is a problem. Sometimes the unemployment rate is so low that there's worried about wages going up, there's worried about capacity in the economy. They want to keep the economy from overheating. It's part of their job. They can't just sort of say, oh, we don't want to invert the yield curve, so we're just going to let the economy go crazy and overheat because that would create even bigger problems.

[J.R. Whalen]

They have to look at the nuts and bolts of the economy to see what is contributing to.

[Justin Lehar]

Yeah, absolutely.

[J.R. Whalen]

And right now they have unemployment at 3.8. Wages are starting to creep higher, though. I suppose there's a lot of room to go before the wages could be seen as some sort of a threat to the economy. And then inflation sort of creeps up. And so they have to keep their eye on a lot of things. They really can't let their foot off the gas here in terms of observing the economy.

[Justin Lehar]

Right, right. Again, it seems fairly accommodative rates are still pretty low. So they probably feel like they have some room to go and they, you know, right now we have a 3, 8 unemployment rate. It seems okay with wages and stuff like that. Well, maybe, you know, if you have three, eight for a year, then wages start going up a lot more and inflation starts going up a lot more. The fact is, though, is that the economy keeps on making jobs. So, you know, maybe at the end of the year you're at three, two. Right. And that's kind of, you know, sort of an amazing place to be. And, you know, we don't know what wages would do then. And you know, again, we want, we kind of want wages to go up.

[J.R. Whalen]

Right.

[Justin Lehar]

That's good for everybody. But the concern is that when you see wages go up, there's other things going on in the economy that can make inflation happen.

[J.R. Whalen]

All right. Well, it's a good reason to keep tuned to Hurt on the street and the [e-mail] and the economic [e-mail] as well. That's HURD on the street columnist Justin Lehar joining us here in our studio. Justin, thanks for being with us.

[Justin Lehar]

Thank you.

[J.R. Whalen]

And that's your money briefing. I'm JR Whalen in New York for the Wall Street Journal.

[Justin Lehar]

Access to affordable credit helps me pay

[J.R. Whalen]

my employees, but I don't really need it.

[Justin Lehar]

Inflation is killing me, but who cares? Big retailers are making record profits. That's why we support the Durbin Marshall credit card bill.

[Advertisement Voice]

See, banks and credit unions help small businesses make payroll.

[Justin Lehar]

This bill would cut the vital resources they need while increasing megastore profits. They deserve it, don't they?

[Advertisement Voice]

Tell Congress, stop the Durbin Marshall money grab for corporate megastores paid for by the Electronic Payments Coalition.