Following over 700 days of inversion, the yield curve for U.S. Treasury bonds returned to normal at the end of August 2024, a sign that markets expect the Federal Reserve to cut interest rates next week in anticipation of a potential recession in Q4 2024 or the new year.

Since July 2022, when the yield on 2-year Treasuries exceeded that of 10-year Treasuries, markets have expected a recession at some point in the future. Despite efforts over the past two years to deliver a “soft landing,” the real U.S. economy remains vulnerable. Consumer sentiment in September 2024 is on par with levels last seen between 2008–10, inflation for key staples remains high, and “Main Street” increasingly finds itself disillusioned by the promise of the American Dream.

Despite headline economic indicators suggesting the U.S. economy is recovering, beneath the surface is a dysfunctional economy that has experienced its longest yield curve inversion since 1929.

Looking back at the past eight recessions in the United States, many of which triggered global recessions, each was predated by a yield curve inversion, with an external shock triggering the recession. The U.S. economy appears to be in a similarly perilous position in 2024, with conflicts in Europe, the Middle East, and potentially Asia all threatening to be trigger events.

In Europe this week, the European Central Bank cut interest rates by a quarter percentage point to 3.5% as growth across the continent slowed in the summer. While inflation has for the most part returned to trend, fears of a protracted decline in output have been raised after industrial output in Germany and Italy slowed. Despite early elections in France, the likelihood of an austerity budget in October remains high, and the post-Olympics growth boom is likely to be short-lived.

ECB President Christine Lagarde, formerly head of the IMF, signaled that further rate cuts could be expected, though one is not anticipated before the end of the year.

While the Federal Reserve has typically led other central banks in setting rates, Chairman Jerome Powell’s timing has come under criticism during his tenure after being too slow to react in 2021 to the inflation that, in many respects, was spurred by President Biden’s fiscal stimulus and Powell’s quantitative easing.

Next week, the Federal Reserve will decide how much to cut rates by, with many hoping for a more aggressive half-point cut after the August jobs report showed employers only added 142,000 jobs in August, fewer than the 160,000 analysts had forecast.

While unemployment remains well under 5%, a fact that has been a key campaign point for Democrats ahead of the Presidential and Congressional elections on November 5th, many believe the data is not capturing the reality on the ground, as the number of people looking for second and even third jobs has increased. Almost half of retirees are considering rejoining the labor market, and the number of young people living with parents has reached 1940s levels.

Having been too slow to increase rates in 2021, Powell raised rates 11 times between 2022 and 2023, an unprecedented pace of change that led to increased volatility in bond markets.

Given a record of being too slow to act in previous years—indecision that has led markets to lose trust in Powell—a half-point cut may be likely, particularly after Powell elected to maintain rates over the summer. But by not cutting rates in the summer, Powell has forced himself to make a critical decision only six weeks out from what may be the most crucial election in U.S. history.

Powell will now also have to consider the impact of any decision he takes on the elections in November. A sizable cut, which many would argue the U.S. economy needs, would support the Democrats’ argument that they are fixing the economy and that their plan is working—a move that could undermine the independence of the Federal Reserve.

The political blowback of a rate cut could be significant for both candidates, and former President Donald Trump has already warned against any cuts in September, given the advantage it would give the Democrats and Kamala Harris.