Stocks finished mildly higher after the Consumer Price Index showed that inflation remained somewhat subdued but stubbornly higher than the Fed would like. Future rate hikes could not be ruled out after the CPI came in slightly higher than last month’s reading.
Roller Coaster of Love. It is Friday and the finish line of the summer dog days grows closer… BUT IT’S STILL SUMMER… so calm down northern hemisphere folks! That said, I think it appropriate to deliver a note to you that has love, rollercoaster, and… the US Treasury yield curve in succinct treatise. Let’s begin with 2 charts. Chart number 1 is the yield spread between 2-year and 10-year Treasury Notes over the past year. Check it out and keep reading.
This chart reminds me of the line “Upside down on the big dip dipper” in the 1975 song Love Rollercoaster by the Ohio Players. You can see on the chart how the spread became flatter and flatter hitting a low in March. What’s more is that the curve is negative, which means that you get less yield for 10-year Notes than you do for 2-year Notes. I won’t get into all the details about why that is bad, but at a high level, it is important to note that, under normal circumstances, the differential should be positive. That is to say, one should get more yield for 10-year paper than for 2-year paper (term premium). Now, you don’t have to have a doctorate in finance to know that these are NOT normal circumstances. As far as the yield curve is concerned, the “not normal” circumstances started in March of 2022 when the yield curve first dipped into negative territory. This yield curve inversion first occurred in response to the Fed rate hikes which directly affect the front end of the yield curve. Short yields are pushed up in response to the Fed’s hiking of Fed Funds. Longer yields can actually fall in anticipation of the economic fallout from the tighter monetary policy. That causes the yield curve to flatten. We know by now that the Fed increased its rate-hiking intensity in the months after March, which pushed the yield curve into permanent inversion by the summer of last year. It has not only remained inverted, but the inversion intensified until March of this year. You will see on the chart that the curve abruptly steepened (though still inverted) following its low. This was in response to the mini-banking crisis that occurred. Markets initially responded to crisis by assuming that the Fed would have to rapidly reverse its tightening policy and possibly even cut rates to avoid a major banking crisis. With that fear passing, the curve resumed its flattening through early July.
So, what is the big deal about all of this? Well, I am sure that you have heard by now that an inverted yield curve has predicted almost every US recession, going way back. That brings me to chart number 2 which is the same as chart number 1, but it goes back to 1975. I have also added in periods of recession, shaded in red. Check out the chart then keep reading… we are close to the finish line, bear with me .
You can see on the chart, that I have circled, in orange, the spread each time it inverted (turned negative). You can also see that each occurrence was followed by a recession. It is important to note that an inverted yield curve DOES NOT CAUSE a recession, it is just a characteristic that has, in the past, predated a recession. If we believe this to be a strong indicator that a recession is on the horizon, we might expect a recession soon, and many analysts point to the yield curve as proof. So, will this potential recession be a bad one considering how far inverted the curve is, and more importantly, when will this recession begin? In answer to the first part of the question, you can probably see by the chart above that length of the recession had little to do with the depth of the inversion, so “we don’t know” by this alone. The real big question of the moment is “when” will a recession start… if we believe this predictor? We can try to deduce an average interval following the inversion, but if you look more closely at the chart, you may find a more reliable predictor. Look closely. Can you see that the yield curve rapidly steepened just before the start of the past recessions? Ignoring why the curve steepened, the pattern is certainly clear. Now go back to chart 1, above . Can you see how the yield curve has steepened in the past several weeks (red drawn arrow)? This has gotten many economic soothsayers a bit on edge recently. Will this bear-steepening continue? If so, will we even get a recession, as we all know that when it comes to markets and economics, the past does not always repeat itself. Maybe not, but we should certainly not ignore it either .
WHAT’S GOING ON BEFORE THE BELL?
The top of the early news list includes Alibaba, Disney, and IBM. Those stocks are down by -2.03%, -0.28%, and up by +0.55% respectively. Alibaba received a target price increase, Disney lost 12.5 million subscribers on its Hostar offering, and IBM is part of a group that teamed up with cryptocurrency Stellar, which has been on the move-up. Other high-profile partners in Stellar include Western Union, Stripe, and the Central Bank of Brazil. You heard it here first . In social media, JPMorgan Chase tops the list for mentions this morning as a Federal judge dismissed a shareholder suit accusing the company of ignoring red flags about Jeffery Epstein. Shares are slightly lower by -0.22% on lower-than-normal volume in the premarket, and the social sentiment is slightly negative.
YESTERDAY’S MARKETS
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