Tuesday, November 12, 2019

"Is The Entire Yield Curve Wrong?"

Yes.
From Upfina:
The yield curve is now normal again across all maturities. If it wasn’t for the way the curve inverted, this would be a recessionary warning.
[Climateer here, this is a reference to the oft-noted pattern of un-inversion which was touted as the coming sure sign that the inversion madness that took hold in mid-August was right, right, right and we were all doomed. There is a serious flaw in that observation, more after the jump]
There was a major selloff in the long bond on Thursday as there was positive news on phase one of the trade deal. It could be signed in early December. We wouldn’t be discussing this action if it was just in one day though. The long bond has been selling off for a few weeks now as the 10 year yield bottomed at 1.46% in early September and recently hit 1.96%. The short end of the curve hasn’t increased as much because the Fed stated it would need to see a big spike in inflation to hike rates. That implies no rate hikes in 2020. The Fed has changed course before, but that’s what is limiting the short end of the curve now. As you can see from the chart below, the difference between the 10 year yield and the 3 month yield has increased from about -50 basis points to 34 basis points.
The big question is what the rise in the 10 year yield means. Traditionally, it predicts higher nominal GDP growth. There has been a rise in both the breakeven inflation rate and the TIPS rate, implying inflation and growth expectations have increased since September. This could be because investors see global growth improving or because of the potential trade deal. Global stock markets have been outperforming the US stock market recently, so there is definitely increased optimism on global growth. Keep in mind, the S&P 500 is at a record high, so outperforming that is significant.

The 10 year breakeven inflation rate bottomed at 1.48% in October and was at 1.69% as of November 7th. The TIPS rate bottomed at -9 basis points in late August and was at 23 basis points as of the 7th. On Thursday, the nominal 10 year yield rose 11 basis points to 1.92% (biggest increase since Trump’s election). The real yield (TIPS) rose 8 basis points to 23 basis points and the breakeven rate rose 3 basis points to 1.69%. The majority of the rise in the 10 year yield on Thursday was caused by increased real growth expectations. This is a big positive assuming you don’t think the market is wrong. The expectations for rate cuts in 2020 have been declining in the past few weeks as optimism has taken hold. There is only a 49.7% chance of any cuts in 2020....
...MUCH MORE

The problem  with the analysis of the yield curve resuming its upward sloping configuration as a harbinger of recession is that the curve usually un-inverts because the Fed forces down short-term rates, which indeed has happened, but which has also been accompanied by a rise in long-term rates.

The 10-year yield got as high as 1.9710 on November 7 and made a post from September 30 look prescient:
Equities: "Financials Are About To Do Something They Haven't Done In Nearly 18 Months" (XLF; KBE)
Our two cents was in the outro:
The 10 - year is currently yielding 1.697 % +0.024, so looking for rates to back up to (and through) 1.90% is a bit of a contrary bet but if it happens bankers (and longs) will be happy.  
Banks and longs are indeed happy with the KBW Bank Index leading the broader market and outperforming by a very big margin. Since October 2 the BKX is up 14.4% versus 6.2% for the Dow Jones Industrials and 6.9% for the S&P 500.

So what now for the broader market?
Higher by year-end, probably enough turbulence between now and then to shake loose some stock from ma & pa investor.
We'll have more next week.
Posted by at