Stocks slid yesterday for a fourth straight session as recession fears continue to grip trader sentiment. The housing market continues to suffer under tight monetary policy according to the latest numbers from the National Association of Home Builders –the Fed is delighted, investors not so much.
Topsy curvy. I am somewhat of a yield curve fanboy, perhaps because it is quite literally the first thing I focused on 30-some years ago when I first started on Wall Street. In fact, I focused on it so much that it became my calling card, ultimately propelling my career into high gear. That is a story for another morning, perhaps not such a cold and dark one. There are only 90 days until spring. Got you thinking, didn’t I? Anyway, let’s get back to the yield curve.
I have been writing quite a bit about the US yield curve which has been inverted since early summer. That is a problem and remains a problem in the US because it is a predictor of recession with a pretty solid track record of success. Of course, there are other signs, but the inverted yield curve is most ominous. Imagine really dark clouds on the horizon that are heading your way. That is what the inverted yield curve represents. Of course, as you know, dark clouds don’t always result in a wicked storm, and they could veer into another direction. They could, but we all typically seek shelter when we spot those clouds. A quick reminder. The yield curve inverts when Fed policy is tight and is expected to remain tight while bond traders are simultaneously expecting economic challenges (and lower inflation) in the future. I probably don’t have to explain what “economic challenges” means. That is the US Yield curve, but the US is not the only country that has a yield curve.
Today, I want to bring your attention to the Japanese yield curve. Japanese monetary policy is somewhat unique. The country’s economy was struggling in the early 2000s and its central bank adapted a Zero Interest Rate Policy (ZIRP), which today, is more common, but was back then considered controversial. When the late Shinzo Abe first took power as the Prime Minister, he instituted measures, now referred to as Abenomics which would take stimulative monetary policy to new heights (the first arrow of his 3-arrows policy). Under Abenomics interest rates would be cut to negative in order to grow the money supply and stimulate the economy. In order to orchestrate all of this properly the Japanese Central Bank had to take on a very “hands on role” with not only policy rates, but also yield curve curbs, and active currency management. Remember, in the US the yield curve, especially longer tenors, are very much controlled by the market. Even when the Fed buys and sells them in the open market, traders are ultimately responsible for moving yields up and down.
In this past 9 months the US Central Bank (Fed) has been raising interest rates, which should not be news to you, and the world central banks (for the most part), have been following suit. Why? For 2 reasons. The first reason is that inflation is gripping other countries as well. The second, and less obvious reason, is to maintain parity between currencies. You see when a country raises rates, foreign investors attempt to take advantage of higher yield by buying its sovereign bonds. In order to do that, currency must be exchanged which causes the currency of the higher yielding sovereigns to rise, while foreign currencies fall. This can be good for a country struggling economically, especially if it is an exporter, like Japan. In that case Japan would be happy to have a weaker Yen. So, low rates and a cheaper Yen have been core to Japanese interest rate policy under Abenomics. In the past 9 months, most of the world’s developed economies have been raising rates to keep up with the US… except Japan, and now you know why. However, WHILE YOU SLEPT, the Japanese central bank made a subtle policy shift by raising its cap on 10-year Japanese Government Bonds, referred to as JGBs, to +0.5% from +0.25%. If you’ve been following me so far, you would know that the rising yields in Japan would likely cause some traders to sell 10-year US Treasury Notes and shift into 10-year JGBs, even though the US notes offer a much higher yield. That trade would cause US 10-year Note yields to rise and the Yen to strengthen against the US dollar… WHICH IT DID. Yields on 10-year notes rose by +6 basis points while the US Dollar Index fell by almost ¾ percent. Check out the following chart of the US yield curve versus the Japanese yield curve and read on for the implications.
The slight steepening of the Japanese sovereign yield curve (the red lines) may not look like much, but it has caused US Treasury yields to rise. As you may know, the Fed is probably happy about that. However, stock investors, as we have learned in the past year, do not favor higher bond yields. The Japanese move can therefore apply negative pressure on US stocks. Now, to be clear, the move was ever so subtle, and yields have only climbed by some +6 basis points, which in recent times is not so much. I really wanted to highlight the fact that policy changes around the world can have positive, and sometimes negative impacts on your US-centric investment, so keep your eyes on the road… er, roads.
WHAT’S SHAKIN’
Newmont Corp (NEM) shares are higher by +1.89% in the premarket. Interest in the mining company, which is used as a proxy for gold (though it mines other minerals as well), has picked up. If you read the note above, you know that the US Dollar declined sharply overnight. Gold has an inverse relationship with the dollar because gold is transacted in dollars. A cheaper dollar therefore causes increased demand for gold. Now you know . Dividend yield: 4.82%. Potential average analyst target upside: +15.7%.
NetApp Inc (NTAP) shares are lower by -1.81% in the premarket after JPMorgan downgraded the stock to neutral citing revenue headwinds from decreased IT spending in the cloud. The company will announce earnings in late February. Dividend yield: 3.37%. Potential average analyst target upside: +30.3%.
YESTERDAY’S MARKETS
Stocks fell yesterday as continued worries of recession hung over the markets. The S&P500 Index fell by -0.90%, the Dow Jones Industrial Average slipped by -0.49%, the Nasdaq Composite Index dropped by -1.49%, and the Russell 2000 Index declined by -1.41%. Bonds pulled back and 10-year Treasury Note yields added +10 basis points to 3.58%. Cryptos fell by -3.71% and Bitcoin slipped by -0.99%.
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