These are uncertain times for the global and U.S. economies and for the wine industry’s economy, too. The International Monetary Fund recently released its World Economic Outlook mid-year update and the story it tells can be as optimistic or pessimistic as you want it to be.
Landings: Soft, Hard, Trampoline
The “glass half full” story is that, for the world economy as a whole, inflation seems to be slowing and global growth is slowing, too. But nothing is crashing … yet. That makes the possibility of a “soft landing” scenario seem more likely than it did just a few months ago. Maybe the slowing economies will moderate rising prices without the need for a sharp, job-destroying recession. And perhaps key central banks will be able to halt interest rate increases before they go too far.
A “soft landing” is far from certain, but it might be possible. That’s good news for a dismal scientist like me because one alternative is the “hard landing” scenario, where jobless numbers zoom to bring inflation down (or the “trampoline landing” possibility, where anti-inflation nerves fail and prices jump pop back up again).
Down the Up Yield Curve
These same issues apply here in the United States, where economic growth seems to be holding up better than in some other regions. But concern is especially heightened by a phenomenon called the “inverted yield curve.” A yield curve plots government bond yields from short-term (30 days) to long-term (30 years). The curve normally slopes upwards as in the chart above from 2021, which makes sense since long-term investors should receive higher returns for taking on the risk associated with longer-maturity assets. You can better guess what economic conditions will be like in 30 days than in 30 years, so the 30-year return should be higher.
A lot of attention is paid to the yield curve among investors. The New York Times and the Wall Street Journal publish yield curve charts daily. And Japan’s central bank actually makes yield curve management one of its policy targets.
In this context, an inverted yield curve, where bond yields are lower for longer-term assets as in the recent chart above, is a puzzle and an alarm. It is a puzzle because it is not clear why investors would be willing to lend longer-term for less. Do they think that inflation, which is relatively high today, is likely to be much lower in the future and so the inflation premium necessary to compensate for price hikes would be lower than today?
What? Me Worry?
Or is it because they expect today’s high-interest rates to push the economy into a recession? Falling incomes tend to drive interest rates down because loan demand is less. And a deepening recession would likely force the Federal Reserve to push interest rates back down. Down to the level, the yield curve seems to predict? That’s something to worry about.
And investors are worried because the inverted yield curve has a very strong record of predicting recessions. The economy doesn’t tank immediately, but eventually. Growth turns negative a year or so after the curve inverts and recession alarms go off.
This Time is Different?
So it has been about a year since the yield curve turned topsy-turvy and it is no wonder that investors are getting nervous. Will the curse of the inverted yield curve take hold later this year or perhaps in the first quarter of 2024? Some so believe in the yield curve’s track record that they are positive that bad news is in the offing.
It is dangerous to argue “this time is different” in the face of a theory that has both logic and history on its side, but maybe this time is really different, and that soft landing will happen. After all, how many times in the past have the conditions that led up to the yield curve flip included a global pandemic, supply chain breakdown, massive fiscal stimulus, and a very hot shooting war involving major powers?
So maybe the curse of the inverted yield curve won’t strike the U.S. economy in the near future. A recession is bound to happen eventually and some people will look back at today’s yield curve situation and see cause and effect, but there are just enough wild card shocks to the system in the past few years to make it plausible that the U.S. economy might “stick” its soft landing after all.
This Wine is Different?
That said, it makes sense to consider how a recession might impact the wine sector. After all, even if the U.S. economy avoids a recession, many of the other major global economic engines including Great Britain, the E.U., Japan, and China look vulnerable today.
If we exclude the short, sharp shock of the covid pandemic period, the last sustained recession was about 15 years ago during the global financial crisis. The weak economy affected the wine industry in many ways, but trading down (to lower prices) and trading over (to more casual wine brands) were part of the story. Would that happen again if a recession showed up now?
Yes, I suppose so, at least to a certain extent. But the wine market has changed in many ways since the last big slump. For example, U.S. wine sales growth was still pretty strong going into that crisis, whereas the market is already slack today and a recession could be more damaging.
Luxury Market Woes?
The trend towards premiumization has strengthened, too, which could affect trading down and trading over. The heart of the market has moved to higher price points that may well display different characteristics than before. And of course, wine sales seem even more dependent on a relatively small segment of the total market, so their particular reactions are very important.
The fact that growth in wine sales has become increasingly concentrated in the luxury part of the spectrum is troubling right now. Sales of luxury goods in general surged during the covid pandemic. Cash from government stimullus payments plus the money that wasn’t being spent on services financed a luxury spending spree. Recent financial reports suggest that tighter consumer budgets have brought a lot of this spending to a halt except at the very high end (think Birkin bags). Even Champagne is feeling the squeeze, I’m told.
The wine economy is experiencing lots of stress and uncertainty these days. It would be great if the inverted yield curve turned out to be a false alarm this time. Fingers crossed!