US Treasuries Signal Recession (Cheat Sheet)

S&P 500 10-24

On Friday, US equity markets rose, despite a tumultuous week. This may be because investors think the Fed will pivot. I don’t think it can stop raising rates until CPI and unemployment fall.

With government bond rates skyrocketing in the United States, equities are under pressure. Investors will likely return to banks now that banks are paying higher interest rates.

I have more bad news to share…

According to Bank of America, there is a 100% likelihood of a recession over the next 12 months, and this week the 10-year and 3-month spreads on Treasuries inverted, signaling the beginning of one.

After the Wall Street Journal reported that some Fed members are worried about over-tightening to combat inflation, Treasury rates dipped from their highs to the end of the week.

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Stocks looked to benefit from the news, with the Dow rising 700 points and completing its biggest week since June.

Earnings have been a mixed bag. Earlier in the week, a slew of positive reports lifted optimism. However, some bleaker reports on Thursday and Friday dragged Wall Street down to reality.

Volatility is projected to continue for the foreseeable future until the Fed provides a clear signal to the markets that it is finished with its rate rise campaign.

KEY EVENTS & CALENDAR

  • Wednesday, October 26 – New Home Sales (September)
  • Thursday, October 27 – Core Durable Goods Orders (MoM) (September)
  • Earnings Reports

Next week will be hectic, with monetary policy decisions in the Eurozone (Thursday, 27) and Japan (Friday, 28). The initial estimates of Q3 GDP for China (likely on Wednesday, 26) and the United States (likely on Thursday, 27) will also be on the agenda.

Other significant numbers are the October PMI indications (due on Monday, October 24th) and US PCE inflation (Friday, 28th).

To top it all off, the results of over 300 businesses from the S&P 500 and Stoxx Europe 600 indexes will be released this week (including Apple, Microsoft, and Amazon in the US and Novartis, SAP, or TotalEnergies in Europe).

MARKET MOVING NEWS

Political Moves

There was a lot of big political news last week overseas. Liz Truss was Prime Minister of the United Kingdom for only 44 days (the previous record was George Canning, who held the position of Prime Minister for 119 days in 1827.) This causes further issues with the GPB and uncertainty, as no one knows who the next PM will be.

Meanwhile, thousands of miles away, Chinese President Xi Jinping is set to take office for a record-breaking third five-year term. Many analysts have speculated that the Chinese Covid lockdowns would stop after Xi’s election because they were used to control people for the election.

However, others have argued that Xi’s continued control in China implies that millions will continue to be subjected to complete or partial COVID lockdowns. It is essential that investors need to watch the “lockdown” policy as it will affect the supply chain of products.

The US midterms are only a few weeks away, and the Democrats are projected to lose control of Congress. If this happens, we will likely see several “government shutdown threats” in the near future as budget battles will ensue.

Coming Disinflation?

This week, Morgan Stanley and JPMorgan claimed that they had finally detected the first indications of disinflation, which could result in reduced inflation rates in 2019. According to Morgan Stanley analysts, inflation should continue to climb in the near future, but they anticipate a decline until 2019.

Delayed Fed Rate Affects

Neel Kashkari, president of the Minneapolis Federal Reserve Bank, said this week that it could take 6–12 months for interest rate increases to be felt, which means that the economy is only now being affected by the rate increase from March.

There will be another four rate increases before two more in November and December. Additionally, Fed members left open the prospect that rate increases might go on into next year, even after they hit 4.5–4.75%, if “underlying” inflation keeps rising.

The fact that it is a whole point more than what the Fed was advocating earlier this year demonstrates its serious concern about inflation. In addition to stating that there is no proof that core inflation has peaked, Kashkari stated he had “poor” confidence in where inflation will stand in six months.

Commodities Supercycle:

The commodities team at Goldman Sachs issued a warning to clients about the possibility of a “commodity-constrained recession,” in which economic activity declines and commodity prices rise as a result of “periodic scarcity,” which further weakens the economy.

Regarding the commodities supercycle, Goldman advises adopting a “buy and hold” approach. Analysts predict a -11.8% loss risk in a scenario similar to the financial crisis of 2008 but a 10-17% upside in the event of a soft landing. Additional benefits will follow after China reopens and imports pick up again.

BONDS

Rates soared in the United States, where rates have not been seen since the financial crisis: 4.28 percent on the 10-year, 4.40 percent on the 5-year, and 4.55 percent on the 2-year, bond yields were unusually relaxed at the beginning of the week, but did not persist.

The financial markets are still anticipating a recession and cannot agree on the Fed’s rate peak. Perhaps because the US central bank is unaware? Liz Truss’ departure has eased Gilts in Europe.

The Gilts remain relatively high at 4.05 percent. The Bund is 2.46 percent, while the OAT is 3.02 percent. On Friday, Greece’s 10-year debt increased to 5.06 percent.

COMMODITIES

OIL

This week, oil prices have leveled out. On Wednesday, the Biden administration announced the release of 15 million barrels of strategic reserves to counter OPEC supply cuts. North Sea Brent, the European benchmark, trades at about USD 92 per barrel, compared to USD 84 for WTI.

These releases, however, are part of a larger plan by Washington to release 180 million barrels of natural gas. In Europe, natural gas prices continue to plummet. As of late August, the Rotterdam TTF traded below EUR 130/MWh, a drop from its peak of roughly EUR 350/MWh.

As an alternative to a gas price ceiling, the European Commission is considering limiting daily spikes. EU leaders also intend to promote cooperative purchasing among member states in order to minimize supply rivalries.

GOLD & PRECIOUS METALS

There was little movement in base metal prices last week. Lead and tin fell in price to USD 1990 and USD 18,900, respectively, while zinc and nickel remained stable at USD 2940 and USD 21,800. Copper trades at roughly USD 7560 per metric ton.

The International Copper Study Group (ICSG) predicts that the copper market deficit will grow to 328,000 tons this year before turning positive by 2023. Gold is trading at its lowest level since January, at USD 1620.

CRYPTOCURRENCY

Ethereum, lost 2.30 percent this week and dropped below $1300, following a drop of 1.50 percent since Monday. Bitcoin has been volatile this week, hovering around $19,000 at the moment.

Due to a weakening economy and few positive drivers for risky assets, crypto enthusiasts must continue to wait.

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