After Donald Trump was elected president, the stock market responded by posting record-breaking highs. 2017 was a banner year for the Dow Jones Industrial Average, which rose by 25 percent. However, U.S. Treasuries fell in 2017, and the spread between two-year notes and ten-year notes fell by a whopping 125 basis points at the end of the year. The spread often signals when the country could fall into a recession.
The last two great recessions in the 21st century, 2001 and 2009, were preceded by yields falling dramatically in the months before they occurred. On the flip side, stocks remained strong in the months leading up to both recessions.
The possibility exists that U.S. Treasuries are sending a warning signal that a recession is on the horizon. The tax bill that passed at the end of December had little impact on bonds with yields remaining unchanged. Lower bond yields coupled with a surge in stocks and strong corporate earnings does not guarantee strong economic growth or a rise in inflation.
Additionally, if the economy shows signs of slowing, the Federal Reserve may not be so quick to raise interest rates multiple times this year. Analysts speculate that the Fed wants to raise rates at least three times in 2018. If the economy does slow down, the yield on 10-year Treasuries will fall while they yield on two-year Treasuries will rise, which results in an inverted yield curve. An inverted yield curve resulted in the recessions of 2001 and 2009.
Although the economy is relatively strong, wage growth has remained stagnant. Since the new tax bill favors higher-income earners, low-income earners will see little benefit from tax cuts with such little wage growth. Lower tax rates are often meant to increase spending, and since high-income earners are not the biggest consumers in the U.S. in relation to gross domestic product, all signs could be pointing to a near-term recession.