Negative real rates are a powerful recession warning

In his 4th Quarter Review and Outlook, Lacy provides some interesting charts on negative real rates and recessions.

Please see the Hoisington Management quarterly review and outlook for the fourth quarter of 2021. The focus is on mine

Real Treasury Bond Yields

Real Treasury yields have fallen into deep negative territory in 2021. In elementary economic models, this event, taken in isolation, would be seen as positive for economic growth in 2022 and would be consistent with the strength indicated by the models of followed by the fourth quarter of 2021.

Lacy a different view though. His analysis shows that negative real returns are associated with recessions.

Over-indebtedness and demography aggravate the situation.


Since 1870, the starting point of reliable data, only 24 full year averages were negative, or just 16% of the 152 readings over that period.

A detailed analysis of the series reveals that 12 of these events occurred in the periods 1914-1920 and 1939-1953, both of which were dominated by major military engagements and their subsequent demobilization – World Wars I and II. and the Korean War.

If we exclude the periods 1914-20 and 1939-53 from the sample after 1870, we still obtain a robust sample of 130 readings. Over this long period, cyclical and secular economic conditions have resulted in negative annual average real treasury yields twelve times, or only 8% of the time. In the eleven cases before 2021, nine of the periods of negative real return coincided with recessions – 1902-03, 1907, 1910, 1912, 1937, 1974-75 and 1980.

Long-term real returns were negative in 1934, which, although not a recession year, occurred during the horrific conditions of the Great Depression (1929-1939). In only one case, 1979, the negative real return occurs during an economic expansion when the economy is not in a very depressed state.

Over-indebtedness and real interest rates

The debt level of the economy is another of the critical moving parts in assessing future economic growth. Based on empirical evidence, theories and peer-reviewed academic research, the massive secular increase in debt levels relative to economic activity has undermined economic growth, which in turn has served to force real long-term Treasury yields to fall. This trend was evident both in the United States and in the most indebted Japanese and European economies.

Real 10-year government bond yields

Economic research provides additional information and evidence on why interest rates fall to low levels and then remain in a prolonged state of depression during times of extreme public sector over-indebtedness. Although their purpose and scope differ, research has shown that extremely high levels of public debt reduce real GDP per capita. In the distant past, debt-financed government spending may have been preceded by stronger sustained economic performance, but that is no longer the case.

When governments accelerate debt beyond a certain level to improve shaky economic conditions, it actually slows economic activity.. While government action may be required for political reasons, governments had better admit that traditional tools would only serve to compound existing problems.. For a restless constituency calling for rapid responses to economic distress and where inaction would be equated with an indifferent and insensitive attitude, this is a virtually impossible task.

In the Summer 2012 issue of the Journal of Economic Perspectives, Carmen Reinhart, Vincent Reinhart and Kenneth Rogoff (to be referred to as RR&R) established a link between extreme over-indebtedness and the level of interest rates. In this publication by the American Economic Association, they identify 26 major historic episodes of public debt distress in 22 advanced economies, characterized by gross public debt-to-GDP ratios above 90% for at least five years, a requirement that eliminates increases purely cyclical debt as well as debt caused by wars. They found that the rate of economic growth is reduced by a little more than a third, compared to the case where the measure of the debt is not respected.

Persistent global weakness

Advanced Countries (AD)

In 2021, the Japanese, Eurozone and Chinese economies, in comparative terms, underperformed the US economy. This trend is expected to continue this year. Due to more massive over-indebtedness and poorer demographics, real GDP in Japan and the eurozone in the third quarter of 2021 was still below the level before the 2019 pandemic. to realize a small gain during this period. The dispersion between the United States, on the one hand, and China and Japan, on the other, could be even greater. Forensic assessments have revealed substantial over-reporting of GDP growth in China and now similar issues have been revealed in Japan.

Prime Minister Fumio Kishida said on December 15, 2021 that overstated construction orders had the effect of inflating the country’s economic growth figures for years. Therefore, the marginal revenue from debt is even lower than reported, as is the velocity of money for Japan and China. Interesting way, Syndicated Bloomberg columnist and veteran Wall Street research director Richard Cookson forcefully argues that “China is a lot like Japan in the 1980s.”

Emerging market economies (EM)

The sharp surge in inflation in 2021 has done far greater damage to emerging economies than to the United States for three reasons. First, a much higher proportion of the household budget is allocated to necessities than in the United States, because real per capita income levels are much lower than in the United States. Second, many emerging market central banks have raised interest rates in 2021.

Another problem arises because most emerging market debt is denominated in dollars. When emerging market currencies crash like in 2021, the external costs of debt servicing and amortization add an additional burden to their borrowers.

Obstacles to growth

In 2022, several headwinds will weigh on the American economy. These include negative real interest rates combined with massive over-indebtedness, poor domestic and global demographics, and a foreign sector that will drain growth from the domestic economy. Emerging and AD economies will both serve to dampen US growth this year and possibly much longer. Negative real interest rates signal that capital is being destroyed and with it the incentive to invest funds in physical investment.

Demographics continue to stagnate in the United States and around the world. Population growth in the United States rose just 0.1% in the 12 months ended July 1, 2021. That was the smallest increase since our nation’s founding in the 18th century, along with two more firsts: (1) natural population increase was less than net immigration, and (2) population increase was less than one million, the first time since 1937. The birth rate also fell to new.


Inflation has been one of the most widely reported and discussed economic factors over the past year. Soaring energy, rents, building materials, autos, food and supply disruptions spurred the year-on-year rise in the inflation rate at the pace the fastest in decades. While some see this increase as a good economic sign, its increase actually had the effect of reducing real incomes by 2%. Even as unemployment fell in 2021, consumers have become more alarmed by falling real wages according to surveys.

With monetary growth likely to slow even more sharply in response to the FOMC cut, the currency’s speed in a major downtrend, coupled with increased global debt overhang, poor demographics and other headwinds to last year’s faster observed inflation is expected to ease significantly in 2022.

Due to poor economic conditions in major overseas economies, 10- and 30-year government bond yields in Japan, Germany, France and many other European countries are well below -United. Foreign investors will continue to be attracted by long-term US Treasury bond yields. Investment in Treasuries should also attract more domestic investors as economic growth disappoints and inflation recedes in 2022.

Thanks to Lacy Hunt

Thanks again to Lacy Hunt for another great Hoisington quarterly review. The excerpts above are only a small part of the full article.

As of this writing, the article is not yet posted to the public, but should be available soon at the top link.

When does the sizzling economy hit a brick wall of recession?

I touched on many of the same points on January 17 in When Does the Hot Economy Hit a Brick Wall of Recession?

I discuss productivity, demographics, and nonperforming debt.

something happened

Something has happened in the last 30 years that is different from the past,says Minneapolis Fed President Neel Kashkari.

Yes, and the Fed has no idea what it is.

The answer is that nonperforming debt is a huge drag on the economy. And the Fed needs to keep interest rates low to support that debt.

When does the recession hit?

If the Fed gets three rate hikes in 2022, then 2023 or 2024. And it might not even take three hikes.

Also check out China’s Central Bank Cutting Interest Rates as Consumer Spending Plunges

Few people believe in Chinese GDP statistics.

China has a GDP target and generally achieves it despite questionable economic reports, electricity consumption, etc., and with an implosion of the real estate sector.

Global economic downturn

China did not decouple from the global economy in 2007 and the United States will not in 2022.

For more, please see the US GDP forecast which stumbles then plunges after retail sales data.

Finally, please see The Fed Expects 6 Rate Hikes by the End of 2023 – I’m Not Doing It and You Shouldn’t Either

Thanks for listening!

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