The Market Today

NATIONAL DAY OF MOURNING

George H.W. Bush, the 41st President, passed away November 30 at the age of 94, the longest-lived president in U.S. history.  Bush enlisted in the Navy at the age of 18 following the attack on Pearl Harbor.  He served as a WWII navy pilot flying 58 combat missions and was awarded the Distinguished Flying Cross.  He narrowly escaped the war after being shot down over Bonin Island by the Japanese.  During this time in the Navy, he married his eventual wife of 73 years, Barbara.  Upon returning home, Bush enrolled at Yale University where he was captain of the baseball team, played in the first two College World Series, is argued to have had the potential to play Major League ball, and graduated with a degree in economics in two-and-a-half years. He moved his family to West Texas, starting an oil business before entering politics.  He served in Congress, Ambassador to the United Nations, U.S. envoy to China, Director of the CIA, Vice President, and President of the United States.  He oversaw the end of the Cold War, the expulsion of Saddam Hussein from Kuwait, and was a key catalyst for the NAFTA trade agreement.  He and Barbara had six children.  They lost a daughter to leukemia, saw one son become Governor of Florida, and saw another become Governor of Texas and 43rd President of the United States.

 

THOUGHTS ON THIS WEEK’S INVERSION OF THE YIELD CURVE

Belly of the Yield Curve Inverts: After four years of tightening, the belly of the yield curve finally inverted on Monday with the spread between the 2y5y and 3y5y segments of the curve turning negative.

 

Economic Impact Come from Wings of Curve Inverting, Not the Belly: From an economic standpoint, an inversion of the belly of the curve has less impact on credit intermediation than an inversion of the 2y10y or 3m10y.  As such, this week’s trading activity is relevant primarily insomuch as it portends a possible inversion of the 2y10y.

 

Historically, the Wings Have Inverted Near the Same Time as the Belly: Currently, the 10-year Treasury yield remains 12 bps above the 2-year Treasury.  However, this spread has tightened meaningfully this year and deserves close attention now that other parts of the curve have inverted. Based on previous examples during the Modern Fed Era, the 2y5y, 3y5y, and 2y10y spreads have all inverted almost simultaneously, sometimes led by the wings and sometimes led by the belly.

 

Lessons from Previous Yield Curve Inversions: An inverted yield curve has proven to be most accurate indicator of economic downturns.  Since 1960, all six U.S. recessions have been preceded by an inverted yield curve. Currently, the economic indicators do not point to an economic downturn and the banking system does not show signs of over-extension.  However, the yield curve has historically inverted well before the economic indicators have flagged recession.  See the linked publication from July for a more detailed discussion of an inverted yield curve.

 

TODAY’S CALENDAR

Mortgage Applications a Positive Surprise for a Change: Mortgage applications for the week ending November 30 rose 2.0% on a 0.8% increase in purchase apps and a 6.2% increase in refi apps.  Purchase apps are now up 13.2% over the last three weeks, the strongest three-week gain since January. While overall applications remain low, the recent uptick has been a welcome surprise for one of the worst-performing sectors in the economy.  At 1:00 p.m. CT, the Fed will release its Beige Book report in anticipation of its final meeting of the year, December 18-19.  The remainder of the economic data scheduled for today has been pushed to Thursday, including the important ADP Employment report.  Fed Chair Powell’s testimony before Congress has not yet been rescheduled.

 

TRADING ACTIVITY

Yesterday – Uncertainty Rattled Equities as Curve Flattening Intensified: U.S. stocks sold off sharply Tuesday just a day after certain spans of the Treasury curve inverted for the first time since the recession and amid uncertainty about U.S. trade and monetary policy. Monday, stocks halved an opening jump on mixed messaging from U.S. officials about what had actually been agreed to with China and after the 2-year and 3-year Treasury yields both closed above the 5-year yield. The trade uncertainty continued Tuesday and the 2y5y and 3y5y Treasury spreads remained inverted. The Dow, S&P 500, and Nasdaq all fell more than 3% for the first time since October 10. Cyclically-sensitive S&P 500 stocks and those tied to trade were led lower by financials which sank over 4.4%, the most since February 8.  Investors are now eyeing the 2y10y spread which is considered a more potent indicator of potential economic problems than the 2y5y or 3y5y spreads. The 2y10y spread flattened for a fourth day since Powell’s “just below” neutral comments last Wednesday to as low as 9 bps. Adding to the uncertainty, New York Fed President Williams gave markets reason to rethink (more below) their interpretation that Fed Chair Powell’s remarks last week were a sign the consensus is for pausing rate hikes after December. And British PM May was dealt a blow by a parliament that reminded markets how difficult reaching a Brexit agreement will be. By the close, the 2-year Treasury yield had dipped 2.6 bps to 2.80% while the 10-year yield had fallen a larger 5.6 bps to 2.91%.

 

Overnight – Global Equities Tripped Up by Tuesday’s Stumble on Wall Street: Global equities are weaker Wednesday after Tuesday’s rout on Wall Street sent the S&P 500 back below its 200-day moving average and the Nasdaq spiraling again into a technical correction. Chinese equities finally fell for the first time since the G-20 meeting between Presidents Trump and Xi resulted in a 90-day truce on any new tariffs. A lack of specificity beyond that was partly responsible for yesterday’s walloping on Wall Street. However, the CSI 300 cut its opening 1.4% drop to just 0.5% after the private Caixin PMI showed better-than-expected services activity in November. Adding support to the turnabout were comments from the Chinese Ministry of Commerce, up until now mum on post-G-20 changes, that the meeting was “very successful” and “China will start…implementing specific issues that have reached consensus, and the sooner the better.” Bloomberg also reported that China was planning to resume purchases of U.S. soybeans and liquefied natural gas, both of which have had tariffs placed on them. European stocks have slowly trimmed a steep opening drop to just 0.7% and U.S. futures were positive in what will be a short trading session as U.S. markets will remain closed for a day of mourning for President George H.W. Bush.

 

NOTEWORTHY NEWS

Williams Still Support Further Gradual Rate Increases: New York Fed President John Williams said Tuesday “I feel that we still have pretty strong tailwinds” carrying the economy into 2019 and that “My baseline forecast is still very positive.” He noted “The labor market is incredibly strong,” and “Inflation is very near our 2 percent longer-run target.” He added that wage growth “has shown signs of increasing,” and he still expects “price inflation to move up a little bit above 2 percent.” Williams gave no signs of supporting a pause of the current rate hikes. “With the economy on a really strong kind of path,” he still believes the best way forward is for “further gradual increases over the next year or so.” Williams said, “Right now I think we’re in a great position, …We’re in a good position to allow the unemployment rate to be below 4 percent for the next few years without really having — I don’t have much concern about inflation pressures picking up. …Over the next couple of years we’re going to continue to learn whether maybe a lower unemployment rate is sustainable without creating inflationary pressures,” he said. However, he also acknowledged that “there are definitely…risks on the horizon,” and that the Fed’s prepared for surprises in either direction. Williams said “we are in a more clearly data-dependent period.”