We started to warn our readers about the impending danger of a yield-curve inversion over a year ago.
- In July of 2018 (see “The Power of the Spread”), we flagged the closing yield spread, linked it to the aging of the economic cycle, and predicted that we would see an inversion by the early spring of 2019. We took readers through the research, explaining that the 3M-10Y spread is the predictive gold standard.
On March 22, 2019, the 3M-10Y began inverting.
- In June of 2019, we updated our case (see “Power of the Spread, Revisited”) and explained why it will compel the Fed to start cutting rates—yet also why such cutting is likely to be too little and too late.
On July 31, 2019, the Fed cut the fed funds rate to 2.25% (upper limit). Yet even after this cut, the Fed remains ever-further behind market expectations of further cuts. Once again, the Fed is chasing market expectations rather than getting out in front of them—like a dog chasing the ball bouncing down the stairs. Hate to say it... but isn't this what the Fed always does before the next recession?
- In our recent podcasts, we have explained that the yield curve is likely deepen, that the inversion is likely to be more “linear” across maturities, and that the Fed’s choices are going to get harder—not easier—with each passing week.
On Wednesday (8/14/19), all this came home to roost.
As of market close, the 3M-10Y spread hit minus 37 bp. That’s more than half of the widest daily negative yield spread (-61 bp) reached during the inversion that preceded the 2008-09 recession. So, in case you’re wondering, we’re well into this thing.
During the day, the 2Y sank below the 10Y for the first time. If there’s one big reason why this is the Rodney Dangerfield of inversions, it’s because the curve is not inverting linearly across all durations. Wall Street, in particular, focuses on the 2Y-10Y gap—despite the fact that its track record in GDP forecasting is inferior to that of the 3M-10Y gap. Well now it looks like this inversion is at last becoming respectable.
As of market close, the 30Y sank of its lowest yield ever. Lately, in fact, the long end has been plummeting with the whip-like velocity. If you’ve been leveraged-long on 30Ys over the past month—down 63 bp in just 23 market days!—you can officially take the rest of the year off. Or, if you like, keep riding this train until it reaches the end of the line.
During the previous day (Tuesday), the YoY rise in the CPI (less food and energy) was a lot hotter than anyone expected: over 2.1% for the second month in a row. The CME probability of a double-cut in September shrank to near-zero. Then, yesterday, the accelerated collapse of the long end of the yield curve signaled just how far the near end of the curve is out of alignment. So how's the market supposed to game the Fed now? The President piled on, calling Chairman Powell “clueless.” What’s he clueless about? “CRAZY INVERTED YIELD CURVE.” Well, at least the President got that one right.
To Trump, the global force behind the inversion is all the rate cutting by other central banks who are “playing the game” (while the Fed remain clueless). Yes, there’s that. But IMO Alan Greenspan was more on the money when he identified the global force as global arbitrage. Where do you expect all the money to flow when long rates are going deep into the red everywhere else while America chugs along at full employment and the Fed prattles on about its “mid-cycle correction"?
More significantly, Greenspan added, “There is no barrier for U.S. Treasury yields going below zero. Zero has no meaning, beside being a certain level.”
Amen to that. This movement has further to go before it ends.
As I said, the Fed’s choices are going to get harder—not easier. But maybe, for that reason, your choices right now become easier—not harder.
