Regarding the factors leading to and resulting from the latest round of market instability, emphasizing why the Federal Reserve ought to refrain from implementing an emergency interest rate reduction.
https://t.co/jpHiwNWAmO#economy #markets @opinion #econtwitter #FederalReserve— Mohamed A. El-Erian (@elerianm) August 6, 2024
The yield curve of U.S. Treasuries, a crucial predictor of a forthcoming recession, flipped positive on Monday for the first time in two years. This shift has sparked concerns that the U.S. economy is on the verge of a decline. An inversion of the yield curve, particularly between the two- and ten-year Treasury yields, generally indicates a recession is probable within the next one to two years.
The ongoing inversion has persisted longer than in earlier instances.
In addition, the unexpected robustness of the US services data as per the Bloomberg summary below adds to the complex situation. The US bond market is experiencing significant fluctuations.#economy #markets pic.twitter.com/U6zwtwREfv
— Mohamed A. El-Erian (@elerianm) August 5, 2024
Typically, the yield curve becomes positive before a downturn commences, with short-term yields decreasing more rapidly than long-term yields as the Federal Reserve is anticipated to lower interest rates to bolster a weakening economy. Matthew Nest, who leads global active fixed income at State Street Global Advisors, remarked, “An inversion serves as a long-term warning sign of a recession, whereas a disinversion indicates that you may be nearing or entering an actual recession.”
The S&P 500 has fallen 8.5% from its peak close on July 16, marking the year’s largest drop. Nevertheless, the index remains up 9.6% year-to-date, inclusive of dividends. Experiencing drawdowns is an inherent risk for long-term investors, who reap rewards only through such fluctuations. $SPX pic.twitter.com/sCot3IdIia
— Charlie Bilello (@charliebilello) August 5, 2024
In previous four recession circumstances, the 2/10 curve had turned positive prior to the onset of a recession, as highlighted in an analysis by Deutsche Bank.
This provides a view of the initial Fed rate cuts in earlier cycles and subsequent S&P 500 returns. Historical instances show that, as observed in 2001 and 2007, the Fed’s rate cuts in anticipation of a recession are not always the bullish signals many believe they to be. pic.twitter.com/jhL9uNmQb5
— Charlie Bilello (@charliebilello) August 5, 2024
The time frame between a disinversion and the start of a recession has varied from around two to six months in past episodes.
Concerns about disinversion in the U.S. economy
The 2/10 curve maintained its inversion since early July 2022, exceeding a prior inversion record dating back to 1978.
Some market stakeholders raised doubts regarding its reliability as an indicator of recession this time due to arising optimism about the U.S. dodging extended economic distress. However, disappointing economic reports from last week reignited recession concerns, leading to swift changes in U.S. interest rate cut forecasts. Over the past week, two-year Treasury yields have plunged more than 50 basis points to 3.84%, while benchmark ten-year yields have dropped approximately 40 basis points, last observed at 3.76%.
The spread between the two reached 0.4 basis points in early trading, flipping positive for the first time since July 2022. Later on Monday, the curve reverted to an inversion, with two-year yields surpassing longer-term yields by around eight basis points. Matthew Miskin, co-chief investment strategist at John Hancock Investment Management, indicated that this disinversion signals a “clear demand from the market for the Fed to reduce rates.” He also suggested, “Whether this demand is warranted remains to be seen, depending on how sustained this risk-averse sentiment proves to be.”
