Global Yield Curve Inversion Spells Doom For The Economy

Global Yield Curve - Stocks Continue To Rebound On Friday

Stocks rallied slightly on Friday. S&P 500 and the Russell 2000 both increased 0.22%. This latest weakness in FAANG and Nvidia crashing 18.8% was from weak guidance. The 0.15% decline in the Nasdaq was impressive.

CNN Fear and Greed index was steady at 10 which is extreme fear. Big potential catalysts for stocks to move higher are a dovish Fed and stocks being oversold.

A main problem is those are occurring because growth is slowing. The stock market rallied without the typical leaders. Consumer discretionary, communication services, and technology fell 0.54%, 0.39%, and 0.11%. This isn’t sustainable.

The biggest winners were utilities and real estate which increased 1.36% and 1.31%.

Global Yield Curve - Fed Rate Hike In December Gone?

We’ve been hearing about how the Powell led Fed is different. Mainly because it will hike rates despite the volatility in stocks.

That seems to be wrong. Recent economic weakness and decline in stocks is beginning to take the December hike off the table.

The Fed’s Harker stated he’s not convinced a December rate hike is prudent. Furthermore, Kaplan said global growth is going to be a bit of a headwind. Finally, Clarida said not to expect a big pickup in inflation next year.

The Fed doesn’t want to hike into a slowdown. Problem is it already did that with its most recent hike. I’m interested if this pause in hikes takes the others in 2019 off the table or if the hike is just delayed a couple months.

In the best case scenario, the Fed stops hikes for 12 months until the slowdown dissipates and then starts to hike again. It’s possible to avoid a recession.

Chances of a hike in December fell from 72.3% to 65.4%. That’s not a huge move, but it’s below the all-important 70% threshold. The Fed doesn’t hike when the percentage is below 70.

Now economic data needs to come in better than expected. Or the Fed needs to make hawkish statements to increase the odds. That’s highly unlikely since growth is weakening and the Fed just made 3 dovish statements.

A hike is beginning to be taken off the table. There has been a shift in expectations for 2019 as well. Now the most likely scenario is rates from 2.50% to 2.75% by the end of the year. One week ago, the most likely scenario was 2.75% to 3.00%.

Global Yield Curve - Big Rally In Treasuries

The 10 year yield was down 5 basis points to 3.06%. That’s 20 basis points from its recent high. It has fallen below the bottom end of its recent range since the start of October. This summer I said didn’t expect the 10 year yield to get above 3%. That was wrong for about 2 months. But it looks like that incorrect streak will end shortly.

Growth and inflation are falling. Personally, I’m very bullish on the long bond.

2 year yield fell 5 basis points to 2.8%. Odds for hikes fell and the rest of the treasury market rallied. The 2 year yield is now down 17 basis points from its cycle peak.

Once the 2 year yield peaks, a recession usually comes soon. The difference between the 10 year yield and the 2 year yield is now 26 basis points.

As you can see from the chart below, the difference between the 10 year yield and the 3 month yield is 72.51 basis points which is near the cycle low.

Global Yield Curve - Inverted

The chart below is unique. It shows the difference between the 30 year yield of various countries and the Fed funds rate.

Usually we compare apples to apples in terms of bonds and interest rates in countries. However, this yield spread has had a good track record as inversions have led to recessions.

The Fed funds rate is above all those 30 year bond yields. Europe and Japan have very low interest rates even though the expansion is long in the tooth.

We may be approaching another slowdown already as both Germany and Japan had negative GDP growth in Q3. That’s before they experienced any rate hikes. I still prefer reviewing the difference between long and short term American treasury yields. But this chart is food for thought.

Global Yield Curve - Weak Philly Fed Reading

The November Philly Fed manufacturing index weakened. This is another sign the economy is weakening. I wouldn’t be shocked if this reading goes negative in Q1 2019.

As you can see from the chart below, it fell from 22.2 to 12.9. That’s way below the consensus for 20 and the low end of the estimate range which was 18.3. This was a weak report across the board. New orders index fell from 19.3 to 9.1. And the index measuring 6 month expectations fell from 33.8 to 27.2. Shipments fell from 24.5 to 21.6.

Inflation was pretty much the same. Prices paid index increased from 38.2 to 39.3. And the prices received index fell from 24.1 to 21.9.

The good news is the capex index, which is in the expectations category, increased from 25.2 to 36.1. Also, expected new orders increased from 43.4 to 46.5.

Keep in mind that this index is volatile and isn’t in concert with other Fed manufacturing reports. This isn’t a terrible report.  It went from great to good, which is terrible in rate of change terms.

Global Yield Curve - Conclusion

Even though stocks have rallied the past 2 days, the S&P 500 still fell 1.61% on the week.

It’s only up 2.34% year to date. That's terrible performance when you consider the high earnings growth this year.

Declining earnings estimates and weak economic reports are previews of what is to come in the first half of 2019. If the Fed doesn’t act appropriately and the tariffs aren’t reversed, there could be a recession in 2020.

The international yield curve signals pain is coming, but the 10-2 year is still normal.

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1 Comment

  • David Rocha

    November 19, 2018

    Thanks for the insight.