Why Central Banks Buying Gold & Institutions Hedging the Yields?While many of us celebrate the stock markets reaching new highs, central banks worldwide are actively purchasing gold, and institutions are hedging into treasuries and yields.
Interest rates are determined by the central banks whereas Yields are determined by the investors.
If you choose to lend or borrow money over a longer period, such as 10 or 30 years, you would typically expect to earn or pay more interest for this extended duration loan contract. However, currently, we are witnessing an inversion of this relationship, known as the inverted yield curve, where borrowers are required to pay higher interest on their short-term loans, such as the 2-year yield we're observing, compared to their longer-term borrowing.
2 Year Yield Futures
Ticker: 2YY
Minimum fluctuation:
0.001 Index points (1/10th basis point per annum) = $1.00
Disclaimer:
• What presented here is not a recommendation, please consult your licensed broker.
• Our mission is to create lateral thinking skills for every investor and trader, knowing when to take a calculated risk with market uncertainty and a bolder risk when opportunity arises.
Yieldcurve
What Next For The Inverted Yield Curve?Markets are notorious for exaggerated expectations. They sense a tiger when all they see is a cat. Expectations on rate cuts have been no different. Despite the Fed’s speak on measured changes to policy rates, markets got ahead of themselves since late last year. Markets are now starting to align their expectations with reality.
US economic data from January stands in stark contrast to December readings. Nonfarm payrolls and CPI are higher than expectations. A resilient economy and rebound in inflation have pushed expectations of rate cuts to much later this year.
According to the CME Group FedWatch tool, the probability of a rate cut at the March FOMC policy meeting dropped from 73% on 29 Dec 2023 to merely 8.5% as of 19 Feb 2024. First rate cut is now expected at the 12 June policy meeting this year. Markets are now pricing four rate cuts instead of six cuts as previously anticipated.
Shift in rate cut expectations has led to a rebound in US treasury bond yields. This paper delves into the factors behind the shift in rate expectations. The paper also analyses a hypothetical trade setup using CME Group Yield futures that investors can deploy to harness gains from revised policy path ahead.
RATE CUT EXPECTATIONS IS BECOMING MORE ROOTED IN REALITY NOW
A stream of recent economic data from the US has pointed to a stronger economy and a rebound in inflation, causing rate cut expectations to shift.
January nonfarm payrolls report showed 353k jobs added, exceeding expectations of 333k and the largest build since January 2023. January CPI report showed annual CPI growth slow from its pace of 3.4% in December 2023 to 3.1% in Jan 2024 but still hotter than analyst expectations of 2.9%.
Core CPI was another concern as it stood unchanged at 3.9%. On a monthly basis, CPI jumped 0.3% MoM. 0.6% MoM increase in rent prices and 0.4% increase in food prices were behind the monthly increase.
On the positive front, PPI fell 0.1% MoM in January, with goods prices 0.4% lower. PPI is just 1% higher YoY against an estimate of +1.3% estimate.
January Retail Sales fell sharply by 0.8% MoM in January. December growth was revised lower from +0.6% to +0.4%. This is expected to lead to a lower GDP growth in Q1. GDPNow model from the Atlanta Fed predicts 2.9% growth in Q1, compared to 3.4% before the release.
As a result of the broadly stronger data and higher inflation, expectations of rate cuts at the 20/March FOMC meeting have fallen from their peak of 74% on 29 December 2023 to 8.5% as of 19 February 2024. Expectations for a rate cut by May have also been scaled back. As of 14 Feb 2024, there is just 35% probability of a rate cut at the 01 May FOMC meeting as well.
Source: CME Group FedWatch
FedWatch indicates 50% probability of a rate cut for the meeting on 12 June 2024, which is up from 40% a week ago.
Source: CME Group FedWatch
The increase reflects the recent retail sales and jobless claims data that was stronger than expected. Both have led to a pullback in bond yields from their 2024 highs.
Source: CME Group FedWatch
The CME Group FedWatch tool indicates expectations of four rate cuts in 2024 as of 18/Feb down from six cuts at the start of the year.
The expectations around rate cuts have also shifted in Fed’s messaging. Atlanta Fed President Raphael Bostic stated that the Federal reserve does not face any urgency in cutting rates due to the current strength in the US economy. Dallas Fed President, Lorie Logan, shares similar sentiments .
Fed Chair Powell echoed the same message. Powell stated the Fed won’t cut rates until it has greater confidence that inflation is moving sustainably to its target. Specifically, he mentioned that a rate cut was unlikely by March. In an interview with “60 Minutes”, Powell suggested that Fed’s base case scenario of 75 basis points of rate cuts in 2024 was unchanged.
As a result of delayed rate cuts expectations, US treasury yields have rebounded.
FOMC MINUTES TO REITERATE HAWKISH POSTURE
Strong economic data and inflation numbers coming in hotter than expected will keep the Fed hawkish in the near term. How long will be anybody's guess?
On 21/Feb (Wed), minutes of the FOMC January meeting will be published. Expectations are for Fed to reiterate its hawkish posture. In anticipation, the 2-year yield futures are up forty-nine basis points (bps) to close at 4.601% as of 16/Feb (compared to 4.112% close of markets on 1/Feb).
Meanwhile, during the same period, the 10-year yield futures jumped forty-five bps to close at 4.295% as of close of markets on 16/Feb.
Taking directional views on the 2-year or the 10-year yields can be difficult when rate expectations are already baked into the yields. Directional views expose the trade to large downside risks vastly reducing reward-to-risk ratio.
In sharp contrast, spread trades enables trades to lock in gains while minimizing downside risks. This paper illustrates a hypothetical treasury spread trade below.
HYPOTHETICAL 10Y-2Y TREASURY SPREAD TRADE
Portfolio managers can better harvest gains from rate moves by trading the closely monitored US Treasury yield spread measuring the gap between yields on 2-year & 10-year Treasury notes. FOMC minutes reiterating a hawkish posture will invert the yield curve even more.
To help traders monitor this spread, the CME Group publishes a Micro Treasury CurveWatch tool which shows daily, weekly, and monthly changes in yields and major yield spreads.
Source: Micro Treasury CurveWatch tool
Portfolio managers can express this view by taking a short position in the CME Group 10-Year Yield Futures (10YG4) and a long position in the CME Group 2-Year Yield Futures (2YYG4).
● Entry: -0.2790 (27.9 bps; enter the spread trade when 10YG4 minus 2YYG4 is -0.2790 bps)
● Target Exit: -0.3690 (36.9 bps)
● Stop Loss: -0.2250 (22.5 bps)
● Profit at Target: USD 90 (9 bps x USD 10)
● Loss at Stop: USD 54 (5.4 bps x USD 10)
● Reward to Risk: 1.66x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Treasury Yields look ripe for further movesCurrent state of the short and long term #Yield.
The 1Yr is underperforming against the 2Yr yield. However, it looks like it wants to push higher.
10Yr vs 30Yr
The 10Yr is performing lil better than 30 but.......
The 30Yr has a BULLISH short term crossing over longer term moving avg, RSI also looks strong. IMO yields are looking good. Seems like there is still treasury selling pressure.
W Pattern Setup on NQJust as in 2002-2003 when America invaded Iraq looking for WMDs (emphasis on the W). George W Bush (again, W) went to eliminate WMDs in Iraq. When said WMDs were not found, it was time to short the Iraq war. However there is a long and profitable path before us until our lies are exposed and we would be fools to not take advantage of this opportunity.
We have the W, all we need is the MDs (I have a few friends that are doctors). This play has tremendous upside potential as we would be well in profit before anyone discovers our misdeeds.
Interest Rates Trading and Hedging Through a New LensIntroduction
In the dynamic world of financial markets, Micro 10-Year Yield Futures stand out as a pivotal tool for traders and investors. These futures offer unique opportunities to navigate the complexities of interest rates, particularly in an environment influenced by key economic indicators. This article delves into how traders can leverage both fundamental economic data and a novel technical analysis approach to optimize their strategies in trading and hedging with these futures.
Fundamental Analysis Approach
Understanding CPI, PPI, and Unemployment Rate:
Consumer Price Index (CPI): This indicator measures the average change over time in the prices paid by consumers for a basket of goods and services. It's a critical gauge of inflation, directly impacting interest rates and, consequently, the yields on Treasury securities.
Producer Price Index (PPI): PPI tracks the average change over time in the selling prices received by domestic producers for their output. It's a leading indicator of consumer inflation when producers pass on higher costs to consumers.
Unemployment Rate: This key metric reflects the number of unemployed workers as a percentage of the labor force. It’s vital for assessing the health of the economy, influencing monetary policy and interest rates.
These indicators, notably their changes, provide crucial insights for active trading, particularly in hedging strategies with Micro 10-Year Yield Futures. For instance, a higher-than-expected CPI or PPI might signal rising inflation, prompting traders to anticipate rate hikes and adjust their positions accordingly.
How to incorporate Fundamental Analysis into the trade decision process?
When making trading decisions for Micro 10-Year Yield Futures, it's crucial to understand the impact of economic reports on interest rates:
Buying (Long) Position Rationale:
When CPI, PPI, and Employment Rate (opposite of unemployment) are all increasing (indicated by green color on the chart), it typically suggests an expanding economy and potential inflationary pressures.
In such scenarios, interest rates are likely to rise to manage inflation. Hence, buying 10-Year Yield Futures could become a strategic move, anticipating a potential uptick in yields.
Selling Existing Long Positions:
A decrease in any of these indicators (CPI, PPI, Employment Rate) signals a potential slowdown or less aggressive inflationary pressure.
Traders holding long positions might consider selling to lock in profits or prevent losses, anticipating a potential drop in yields.
Selling (Short) Position Rationale:
If these reports show a decreasing trend (indicated by red color on the chart), it suggests economic contraction or reduced inflationary pressure.
Lower interest rates are often introduced to stimulate economic growth in such conditions. Shorting 10-Year Yield Futures could be advantageous as it would benefit from a potential fall in yields.
Buying Existing Short Positions:
An increase in any of these indicators (CPI, PPI, Employment Rate) signals a potential expanding economy and potential inflationary pressures.
Traders holding short positions might consider buying to lock in profits or prevent losses, anticipating a potential rise in yields.
Rationale Behind the Rules:
These rules are based on the traditional economic relationship between inflation, economic activity, and interest rates.
Rising inflation or strong economic growth (indicated by higher CPI, PPI, and Employment Rates) often leads to higher interest rates to prevent the economy from overheating.
Conversely, decreasing indicators suggest an economy that might need stimulation, often leading to lower interest rates.
By aligning trading strategies with these fundamental economic principles, traders can make more informed decisions, leveraging economic trends to speculate or hedge effectively.
Technical Analysis Approach
Yield Extremes and Curve Analysis:
This approach involves charting and combining the 2-Year and 30-Year yield futures contracts in one chart.
Analyzing the relationship between these yields provides insights similar to traditional yield curve analysis in a much more accessible format.
Key Indicator: A crossover between the 2-Year and 30-Year rates signifies a substantial shift in market sentiment and economic outlook.
How to Incorporate Technical Analysis into the Trade Decision Process?
As said, the crossover of yield rates between the 2-year and the 30-year yields is a pivotal event, suggesting significant changes in the yield curve. Here's how to interpret and act on these occurrences:
Identifying the Crossover Event:
A crossover event occurs when the 2-year yield rate overtakes the 30-year rate, or vice versa.
This event is indicative of a significant change in the interest rate environment, reflecting shifts in economic expectations and monetary policy.
Trading Strategy Based on Micro 10-Year Prior Price Action:
When the crossover occurs, the immediate strategy depends on the recent trend in the Micro 10-Year Yield Futures prices.
If the Micro 10-Year Yield was trending upwards prior to the crossover, it suggests bullish sentiment in the shorter term. In this scenario, traders could consider taking a short position, anticipating a potential reversal or bearish shift in the market.
Conversely, if the Micro 10-Year Yield was trending downwards, indicating bearish sentiment, traders could consider a long position post-crossover, capitalizing on the potential for a bullish reversal or recovery in prices.
Rationale Behind the Trade Rules:
The crossover event between the 2-Year and 30-Year yields represents a pivotal shift in market dynamics, often reflecting changes in economic policy, inflation expectations, or investor sentiment.
Prior price action in the Micro 10-Year Yield Futures provides a context for these shifts, indicating the market's prevailing trend and sentiment.
By aligning trading actions with both the yield curve dynamics (crossover event) and the recent trend of the Micro 10-Year Futures, traders can make informed decisions, leveraging the market's anticipated reaction to these significant economic indicators.
Market Outlook and Trade Plan
Keeping in mind the below tick and (Average True Range) ATR values, based on our analysis, we could express our market views through the following hypothetical set-ups:
Trade Plan for the Fundamental Analysis Approach:
ENTRY: Wait for the next CPI, PPI and Employment Rate reports and consider executing a trade if all 3 reports are either positive (long) or negative (short).
STOP LOSS: Located 1 Monthly ATR away from the entry price
Trade Plan for the Technical Analysis Approach:
ENTRY: The crossover may confirm itself at the end of the day. Wait for such confirmation and consider executing a short trade once confirmed.
STOP LOSS: Located 1 Monthly ATR away from the entry price
Tick Value: 0.001 Index points (1/10th basis point per annum) = $1.00
Monthly ATR: The average volatility is measured as 0.509 at the time of this report
Trade Example: If the 2-Year yield rises above the 30-Year yield amid rising CPI, consider a short position anticipating rate hikes.
Reward-to-Risk Ratio: Calculate this ratio to ensure a balanced approach to potential gains versus losses.
Risk Management in Futures Trading
Effective risk management is paramount. Utilize stop-loss orders and consider hedging techniques to mitigate potential losses. Understand the significance of economic reports and yield curve shifts in making informed decisions.
Conclusion
Micro 10-Year Yield Futures offer a versatile platform for interest rate trading and hedging. By combining monthly economic updates with a unique yield curve analysis approach, traders can navigate these markets with greater confidence and strategic foresight.
When charting futures, the data provided could be delayed. Traders working with the ticker symbols discussed in this idea may prefer to use CME Group real-time data plan on TradingView: www.tradingview.com This consideration is particularly important for shorter-term traders, whereas it may be less critical for those focused on longer-term trading strategies.
Disclaimer: The trade ideas presented herein are solely for illustrative purposes forming a part of a case study intended to demonstrate key principles in risk management within the context of the specific market scenarios discussed. These ideas are not to be interpreted as investment recommendations or financial advice. They do not endorse or promote any specific trading strategies, financial products, or services. The information provided is based on data believed to be reliable; however, its accuracy or completeness cannot be guaranteed. Trading in financial markets involves risks, including the potential loss of principal. Each individual should conduct their own research and consult with professional financial advisors before making any investment decisions. The author or publisher of this content bears no responsibility for any actions taken based on the information provided or for any resultant financial or other losses.
US Equities Intrinsic AverageThe yellow resistance zone is expected to be pivotal for the stock markets. Although some indices appear close to ATHs, the presented spread graph suggests the intrinsic value of the US stock market isn't even half of the previous highs.
Same graph with monthly candlesticks:
Fundamentally:
Although rate cuts are expected, historically they mark the beginnings of bear markets
The significant 7 makes up more weight than Canada, France, China, UK, and Japan combined.
With de-dollarisation and world progressively relying less on US doesn't look positive for the 7 giants
Timing the markets can be difficult, but with
the recent deterioration in the labour market
shaky elections in 2024 (likely to be priced in before)
historically strong equities from January to mid-February
--> I speculate a bear takeover in early 2024.
For intrinsic graph sceptics, here is a simple average of the 4 indices:
Another Inverted Yield Curve with Even More Predictive PowerThe Federal Reserve Chair Jerome Powell spoke again today at a Brookings Institution event. His comments sparked a rally in markets (likely including short covering) that pushed the S&P 500 SP:SPX up about 122 points, or 3.10%, to close at 4080. The Nasdaq 100 NASDAQ:NDX rose 4.58% on the day, closing at 12,030.
But the bond market is sending less sanguine signals. The 10Y/3M yield curve inverted further today. Its inversion is currently the deepest since the slightly deeper inversion of this segment of the yield curve in 2000-2001 inversion, which had presaged the 2-year bear market from 2000-2002.
The 10Y/3M curve has been researched more than the more widely known 10Y/2Y curve (also known as the 10s/2s). Experts say inversions of the 10Y/3M serve as better predictors of recession than the 10Y/2Y curve.
The yield curve has remained inverted for over a month now. This qualifies as a "persistent inversion" that creates a recession signal. But the recession does not always follow immediately. According to Jim Bianco of Bianco Research LLC, "The average lead time" until the recession arises "is 311 days, or about 10 months."
What does this offer for traders then? On days when equity markets are rallying like there is no tomorrow, it tells us that markets are not out of the woods despite the buying frenzy. It means that a recession is more probable than not in the next year. But it doesn't tell us much about where prices are headed in the near term (technical analysis of price itself works better for this purpose). Just because a recession will likely begin in the coming weeks or months does not necessitate that equity markets plummet in a straight line to the ideal target. Many, including this author, wishes it could be as straightforward and predictable.
So traders should also keep in mind that inverted curves are not a trading signal. They are part of the broader economic and rate-policy context within which equity markets operate. It helps me to know that markets are not likely to resume a long-term uptrend until the recession has ended.
The bond market tends to sniff out the problems in the economy long before other markets. And equity markets can ride on hope and desperation for much longer than anyone expects—just as this unexpected bear rally carried SPX price from the October 13, 2022 low all the way back above the 200-day MA today and higher to close at 4080.11.
Below is a chart of the 10Y/2Y yield curve, which is also inverted.
Supplementary Chart A:
To compare the current 10Y/2Y inversion with some historic inversions, consider reading this prior post from July 2022 on the 2s / 10s yield curve inversion, and be sure to hit the refresh button to see the most recent months of data. The Wall Street Journal Confirmed in recent days, by the way, that the 2s / 10s curve
Supplementary Chart B:
Finally, on a monthly chart, one can easily see that the 2s / 10s curve inversion is the deepest one on record—at least as far back as the chart allows. Hat tip to @SPY_Master for pointing this record-breaking inversion recently.
Supplementary Chart C:
BluetonaFX - GBPJPY Ascending Triangle PatternHi Traders!
GBPJPY is in an ascending triangle and is heading for the 183 handle.
Price Action 📊
The market is currently in an ascending triangle with higher highs and higher lows. After the low price rejection, the market has shown bullish price action signs. The market is also currently trading with momentum; the 20 EMA has just been broken with momentum, and we are looking for a close above it.
Fundamental Analysis 📰
The BoJ disappointed the markets with its underwhelming stance on the yield curve. The bank stated that they will maintain the target level of 10-year Japanese government bond (JGB) yields at around zero percent.
Support 📉
180.770 PREVIOUS DAY'S LOW
Resistance 📈
183.758: PREVIOUS WEEK'S HIGH
184.392: RANGE ZONE HIGH
Risk ⚠️
No more than 2% of your capital.
Reward 💰
At least 4% of your capital.
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Trade safely and responsibly.
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Harnessing Gains from Yield Curve NormalisationNot too long ago, watching interest rates was as boring as looking at wet paint dry. Not anymore. Interest rates and currencies are as interesting as they get. The US dollar has been clocking moves more akin to an EM currency.
The greenback has been on a rollercoaster ride over the past three months in line with market expectations of Fed’s interest rate policy path. This paper is set in three parts. First, the background to rising rates and spiking yields leads to a brutal bond sell off. Then, the paper evaluates the case for further Fed rate hikes. In the third and final part, it dwells into factors that support a rate pause.
It is not just the rates but also the term structure of rates that’s gone off-the-chart. This paper posits a hypothetical spread trade inspired by the divergence in 30Y and 10Y treasuries with an entry at 13 bps and a target at 40 bps hedged by a stop at 5 bps delivering a reward-to-risk of 1.5x.
RISING RATES AND SPIKING YIELDS
Fed’s commitment to taming inflation with a higher-for-longer stance leads to a surging dollar. Spiking bond yields help reign in inflation through tightening monetary conditions.
The US 10Y Treasury Bond Yields surged to their highest level since 2007, by 20% or 0.8 percentage points since July 17th.
Chart 1: US 10Y and US 2Y Treasury Yields
Yield and Bond prices are inversely related. Surging yields have hammered bond prices lower resulting in a staggering record sell-off. Leveraged funds hold a record net short positioning in US 2-year and 10-year Treasury Futures.
Chart 2: Record Net Short Positioning by Leverage Funds
This brutal selloff has pushed yields to their highest levels in more than 15 years. Among others, portfolio managers and traders can position themselves one of the two ways:
Risk Hedged Yield Harvesting: Harvest risk hedged treasury yield using cash treasury positions and Treasury futures to generate income over a long horizon, or,
Gain from Yield Curve Normalisation: Deploy CME Micro Treasury Futures to engineer a spread trade to realise gains from a normalising yield curve.
In a previous paper , Mint Finance illustrated the first. Distinctly, this paper covers spread trade using CME Micro Treasury Futures.
THE CASE FOR HIKING
The September FOMC meeting re-affirmed a higher-for-longer rate regime. Though there was no rate hike, the updated Fed’s dot plot signalled very different expectations for the rates ahead.
The dot plot was updated to show a final rate hike in 2023 and fewer rate cuts in 2024.
Chart 3: Contrasting US Fed’s Dot Plot between 14/June versus 20/September ( Federal Reserve )
The Fed has adequate grounds to crank up rates even more as highlighted in a previous paper . These include (a) American exceptionalism where the US Economy has been remarkably resilient, (b) Expensive Oil due to geopolitics & receding base level effects, and (c) Brutal Lessons from past on the folly of premature easing.
THE CASE FOR PAUSE
Factors described above have led markets to price another rate hike at Fed meetings later this year. Those views have started to tilt further towards a pause since the start of October as per CME FedWatch tool.
Chart 4: Target Rate Probabilities For 13/Dec Fed Meeting ( CME FedWatch Tool )
Bond yields have surged, helping the Fed with their fight against inflation. Yields on US Treasuries surged to their highest since 2007. As yields are inversely proportional to bond prices, this is the equivalent of a major selloff in the bond market.
Three reasons behind the selloff:
1. Steepening Yield Curve:
Yields are finally catching up to market rates, especially for long-term treasuries; yield curve is steepening
Chart 5: Yield Curve is Steepening
2. Rising Sovereign Risk Premia: The US national debt passed USD 33 trillion and is set to reach USD 52 trillion within the next 10 years. Investors are demanding higher risk premia as compensation for default risk by a heavy borrower.
Chart 6: US Debt to GDP Ratio
3. Higher Yield to Compensate for Scorching Inflation: Investors are demanding higher real rates amid a high-inflation environment.
Chart 7: Real Yields are marginally above zero
Bond yields seem to be peaking. Solita Marcelli of UBS Global Wealth Management opines that the recent upward momentum in yields has been spurred largely by technical factors and is likely to be reversed given the overhang of uncertainty over underlying forces guiding the Treasury market.
Higher bond yields support a case for a Fed pause. This is because rising treasury yields do part of the Fed’s job. Higher treasury yields tighten financial conditions in addition to being a drag on the economy.
The Fed officials shared similar sentiments over the past week:
San Francisco Fed President Daly noted the moves in markets “could be equivalent to another rate hike”.
The Atlanta Fed chief opined that he doesn’t see the need for any more rate hikes.
The Dallas Fed President remarked that such a surge in bond markets may mean less need for additional rate increases.
The Fed has made it amply clear many times that it is data dependent. The data about the economy is positive. And that is concerning. Jobs data last week, and a sticky CPI print raise concerns that the Fed’s hand might be forced to hike despite US inflation being low among G7.
Chart 8: US Inflation is among the lowest within G7s
HYPOTHETICAL TRADE SETUP
Are we witnessing peak rates? In anticipation of the peak, investors can use CME Micro Treasury Futures to harness gains in a margin efficient manner. Micro Treasury Futures are intuitive as they are quoted in yields and are fully cash settled. They are settled daily to BrokerTec US Treasury benchmarks for price integrity and consistency.
As highlighted in a previous paper , each basis point change in yield represents a USD 10 change in notional value across all tenors, making spread trading seamless.
Setting up a position on yield inversion between 2Y and 10Y Treasuries is exposed to significant downside risks from near-term rate uncertainty.
Instead, a prudent alternative is for investors to establish a spread with a short position in 10Y rates and a long position in 30Y rates. The 30Y treasury rates demand a higher term premium due to their longer maturity.
Presently, this premium is just 0.15%. In the past, this premium has reached as high as 1% during periods of monetary policy shifts with yield curve steepening.
Chart 9: US Treasury Inverted Spreads
Furthermore, downside on this spread is limited as the 30Y-10Y premium scarcely falls below 0% unlike the 10Y-2Y premium which has been in deep inversion for the past year. A long position in 30Y Treasury and a short position in 10Y Treasury with:
Entry: 0.130 (13 basis points)
Target: 0.4 (40 basis points)
Stop Loss: -0.05 (5 basis points)
Profit at Target: USD 270 (27 basis points x USD 10)
Loss at Stop: USD 180 (18 basis points x USD 10)
Reward to Risk: 1.5x
Chart 10: Hypothetical Spread (Long 30Y & Short 10Y) Trade Set Up
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Yield Curve Flattening. Can the Fed afford to pull the trigger??The U.S. Yield Curve (US10Y-US02Y) flattening is a textbook sign of recession. However the S&P500 (blue trend-line) keeps recovering and rising from the 2022 Inflation Crisis. At the same time, the Inflation Rate (black trend-line) may have taken a pause but is on a strong decline, while the Interest Rate (orange trend-line) is turning sideways.
The question on everyone's mind is this: "Can the Fed afford to pull the trigger and start lowering rates again?". There is no easy answer to this. Recent history on this chart shows that a rising curve along with lowering interest rates and inflation decline is correlated with Bear Cycles. Notable examples are 2007 - 2008 and 2000 - 2001. At the same time notable exception is 2020. In 1995 both Interest and Inflation rates turned sideways so the stock market extended the aggressive rally into the DotCom bubble.
In 1989 - 1990 however, the Curve flattening coincided with a non-stop drop on the Interest rate while in late 1990 Inflation also started to drop. The stock market didn't enter any Bear Cycle but insted kept rising slowly but steadily. Approximately what is taking place now. Do you think we are in a same pattern and stocks will be unfazed if the Fed starts lowering the rates?
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BTC Vs US02US30 SPREAD - Interesting
• 2s30s spread : The US2US30 spread refers to the yield spread between the 2-year and 30-year U.S. Treasury bonds. The chart visualizes the difference, or spread, in yield for these two bonds over time.
The 2-year bond represents more of the short-term outlook, whereas the 30-year bond is more indicative of long-term expectations. So, when people refer to the US2US30 yield spread, they're essentially talking about the difference between short-term and long-term interest rates.
During typical economic conditions, investors demand higher interest for lending money over a longer period, thus the yield of 30-year bond is higher than the 2-year. However, during economic uncertainty, the spread can narrow or even become negative (also known as a yield curve inversion), which can be viewed as a potential indicator of a forthcoming economic recession.
Yield Curve:
1. A yield curve is a graphical representation of the yields available for bonds of equal credit quality and different maturity dates. It is used to measure bond investors' feelings about risk and can significantly impact investment returns.
2. Different types of yield curves can exist reflecting the short, intermediate, and long-term rates of various bond types, such as Treasury bonds, Municipal bonds, or corporate bonds of specific issuers.
3. The shape of the yield curve varies: a normal yield curve slopes upward indicating higher yields for long-term investments; a steep curve usually signals the beginning of economic expansion; an inverted curve suggests potential economic slowdown as long-term investors settle for lower yields; and a flat or humped curve indicates little difference in short and long-term yields.
4. The yield curve can help gauge the direction of the economy, serving as a predictor for potential turning points in the economy.
5. Yield curves allow bond investors to compare Treasury yields with riskier assets such as Agency bonds or corporate bonds. The yield difference between these is referred to as the "spread", which widens during recessions and contracts during recoveries.
Soft Landing?A lot of market participants are falling for the Fed's illusion that a soft landing has been achieved. However, the charts are still warning that a recession is coming.
The chart below shows the extreme degree of inversion between the 10-year Treasury bond and the 3-month Treasury bill. The current inversion is the worst in over 40 years.
A yield curve inversion reduces bank lending for various reasons, one of which is the removal of the incentive for banks to borrow at lower short-term rates and lend at higher long-term rates. Since bank credit is how most money comes into creation, a yield curve inversion is, therefore, a sign that monetary conditions are deteriorating. Indeed, manipulating the interest rate is how the central bank controls the money supply and induces a recession.
The impact of rate hikes always occurs on a lagging basis. The lag can last anywhere from several quarters to several years. As the infographic below shows, an economic recession will likely begin in the U.S. between Q4 2023 and Q4 2024.
The warning signs of the coming liquidity crisis are everywhere.
In a prior post (shown below), @SquishTrade and I pointed out that a major disparity between the volatility of bond prices and the volatility of equity prices is occurring. This extreme disparity could be a warning that much greater volatility for equity markets has yet to come.
Even for stocks that have experienced a strong rally in 2023, the basis of their surge is largely unsupported by dollar liquidity levels. In the chart below, the price of NASDAQ:NVDA is compared against the dollar liquidity index.
This is further confirmed by the below chart, which shows how extreme the price of NASDAQ:NVDA as a ratio to the price of a risk-free 10-year Treasury bond has become. Never before have investors been willing to pay so high of a risk premium to hold Nvidia's stock.
While anything is possible, the charts suggest that there isn't enough money in the economy to support the payment of debt at current yields. The below chart shows the price of long-term government Treasurys (adjusted for interest payments) as a ratio to the M2 money supply.
There is simply not enough money in the M2 money stock for market participants to be able to pay all newly issued debt at the current high rates. When the liquidity issues begin to mount, the Fed will quickly pivot back to new money creation, as it did in March 2023 when it abruptly created the Bank Term Funding Program (BTFP), which is the latest of the many tools that the Fed uses to create new money.
However, when the economy begins to slow, this time around central banks will get trapped because of commodity price inflation. Although commodity prices are generally disinflating at the present time, this slow disinflation is merely forming a bull flag on the higher timeframes.
With unemployment also bull flagging on the higher timeframes, when commodity prices and unemployment concurrently break out, the result will definitionally be stagflation.
Important Disclaimer
Nothing in this post should be considered financial advice. Trading and investing always involve risks and one should carefully review all such risks before making a trade or investment decision. Do not buy or sell any security based on anything in this post. Please consult with a financial advisor before making any financial decisions. This post is for educational purposes only.
Most important chart there is right now. The bear steepener.Those who are not skeptical about pattern breakouts will take this chart seriously.
Increasing The DXY Profit Target to $154 From $103The DXY after catching a rally off a 4-Hour Bullish Butterfly, has reached my price target of $103, and if it gets above that zone, then I think the DXY will have plenty of room to make multi-decade highs due to The High Interest Rates, Tightening Credit Conditions, and The Deflation that is now being priced into the US Bond Market.
If things go as expected beyond the $103 zone, we will likely have entered into a Harmonic Wave Structure that should take us up to the Macro 0.886 Fibonacci Retrace which sits all the way up at $154
The RSI and PPO are both sitting at the mid point which is an area where it can often go just to reset before making higher highs in price.
Yields topping soon and resuming trend toward ZERO$TNX is approaching historical resistance... expecting trend resumiption once local top is in...
Market Analysis July 9Welcome to the latest market analysis video dedicated to:
DAX's bearish structure and sell on rise trade.
German and US bond yield curves signal de-inversions ahead, calls for caution for those "long risk."
Did Friday's nonfarm payrolls report signal stagflation ahead?
Key data to watch out for: US CPI and China's PPI.
Technical set up in the dollar index.
Hope you enjoy, please leave comments. Thanks
How to position for yield curve un-inversions!It has been some time since we delved into the intricate world of interest rates and their prospective trajectories. With the yield curve experiencing significant movement in recent weeks, it's high time we reassess our stance. Following a staggering 500 basis points increase, we now find ourselves potentially nearer to the end of the rate hike cycle than ever before. The recent hawkish pause announced in the last meeting has left market participants on tenterhooks, pondering the future course of action in the ongoing battle against inflation.
Given the downward trend in inflation and the possibility of at least one more rate hike, 'real' yields have ascended beyond the 0% level, as depicted in the chart above. Since the 2010s, real yields have consistently struggled to surpass the 1.2% level. However, the recent lower inflation prints place the 'real' yield at a new decade high of 1.25%. So, how does the yield curve inversion behave during periods of real yields? Interestingly, in three of the past four instances, the curve 'un-inverted' once real yields exceeded 0.
Of greater significance is the yield curve's response after the Fed cuts rates. Since 1989, this has been a key signal of the yield curve un-inversion. Given this event's proximity and the current 2Y-10Y yield curve, we contemplate the optimal strategy to capitalize on this likely un-inversion.
One approach is to examine all possible inversion combinations between the 2, 5, 10, and 30-year yields. All these combinations present an inverted curve, except for the 10Y-30Y segment.
Upon dissecting the analysis to focus solely on 2-year inversions, we observe the following:
The 2-year inversion is generally the steepest, with the 2Y-10Y ranking as the most inverted segment of the yield curve. All inversions anchored with the 2Y are at their all-time highs, plunging us into uncharted waters.
In contrast, the 5-year and 10-year yields exhibit more subdued movements. Their inversions have yet to reach all-time highs, and the overall range of movement is relatively restrained.
Therefore, to maximize returns on the un-inversion move, one could position to short either the most inverted section of the curve, the 2Y-10Y, or the 2Y-30Y, which typically experiences the largest movement upon un-inversion.
Handily, CME has the Micro Treasury Yield Futures, quoted in yield terms, which allows us to express this view in a straightforward manner allaying the complications with DV01 calculation. By creating a short yield spread position, we are not merely speculating on the direction of individual yields but rather on the relative movement between them. Trading the yield spread instead of just an outright position in a single part of the curve also protects us from parallel shifts in the yield curve, especially in volatile times like these. This strategy takes advantage of the yield curve dynamics, particularly the inversion trend we've been observing. We create the short yield spread position by taking a short position in the Micro 2-Yr Yield Futures and a long position in the Micro 10-Yr Yield Futures or Micro 30-Yr Yield Futures to express the curve un-inversion view, with 1 basis point move equal to 10 USD.
The charts above were generated using CME’s Real-Time data available on TradingView. Inspirante Trading Solutions is subscribed to both TradingView Premium and CME Real-time Market Data which allows us to identify trading set-ups in real-time and express our market opinions. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
Disclaimer:
The contents in this Idea are intended for information purpose only and do not constitute investment recommendation or advice. Nor are they used to promote any specific products or services. They serve as an integral part of a case study to demonstrate fundamental concepts in risk management under given market scenarios. A full version of the disclaimer is available in our profile description.
Reference:
www.cmegroup.com
www.cmegroup.com
www.cmegroup.com
Bond Yield Inversion vs. SPXThis is nothing new, really. People who have been in markets long enough know that when short term bond yields (3 month and 2 year, for example) come up to meet and invert to a higher yield than longer term bonds (like the 10 year, 30 year etc) that it often precedes a large market sell off as well as a recession that affects most everyone, not just stock prices.
On this graph, I maybe got a little carried away. I have the 1 month, 3 month, 1 year, 2 year, 10 year and 30 year as well as the actual Fed Funds rate with SPX in the background.
This goes back to the mid 1990s, you can see the dotcom boom, you see the yields invert, SPX tops and then takes near 3 years to finally find bottom before reversing course.
Unfortunately for long only stock holders, the treasury yields started to climb with stocks as well until they inverted in 2007 once more. Stocks started to come down, and, well, then 2008 happened...
You can see that in general, the fed funds and the shorter term yields find a plateau at their top, tend to stay there for awhile (sometimes for a whole year), then as they start to come back down, the stock market tends to be near its highs, and then the stock market starts to come down.
Big money tends to see higher treasury yields as a safer haven for their money than stocks at this point. If you have the ability to hold the treasury to expiration, you're guaranteed to get 100% of the money back plus whatever the yield % was at time of purchase as interest paid to you by the government.
Furthermore, there is an inverse relationship between bond yield percentage going up, and the value of bonds on the open market. As yields go up, the value of bonds goes down. Vice versa, as yields start to retract, bond values go up. So, there is high incentive to start buying a lot of bonds as the rates plateau near the top. Maybe some of these large hedges start to sell some equities as a hedge and buy more bonds as we get to that point. Rebalance their portfolio to be more bond-heavy.
Higher short term yields, higher fed funds rate also generally mean that the cost to borrow money for anyone is higher. Higher interest rates means more money out of the pocket of anyone borrowing to pay interest. Bonds themselves are just government debt.
The stock market is generally forward looking, so it's often making moves in response to moves in the bond market before main street really starts to feel the effects of the tightening in a meaningful sense. As time has gone on, it seems the market is reacting earlier and earlier to rate hike cycles.
Take 2018 for example, the yields didn't really invert until they all were already on their way back down. 2018 had volmeggedon to deal with to start the year, then came back, set a new high, then had a very rough second half of the year as bond yields plateaued. But, as the market saw that this small rate hike cycle didn't do any meaningful harm to the economy and started retracting, stocks took off again:
Then COVID happened, yields plummet, cost to borrow was as cheap as it ever has been, the government pumped money everywhere to try and prevent a complete collapse of everything, stocks were off to the races harder than ever before after finding bottom just a few weeks into the pandemic.
But, mentioning the market kind-of getting ahead of itself again, we had all of 2022, as it became apparent that inflation was now raging and bigger rate hikes than we've seen since the Great Financial Crisis would be necessary, the stock market sold off despite the economy still showing very solid recovery out of the pandemic.
But now, treasury yields are still climbing, but so are stocks. Treasuries hit a little hiccup in March as a couple regional banks were found to be overlevered in treasuries that had too low of a yield, and as more people began withdrawing money and those banks needed liquidity, they had to sell those treasuries at a loss. If they didn't have to come up with that liquidity and were able to allow those treasuries to mature, they make that small percent of interest for holding them. But because they were forced to sell them as treasury values were at a low because they had inadequate liquidity to cover deposits being withdrawn.
But, now maybe surprisingly, despite some of the troubles and the market sell off for most of 2022, we're now not all that far off of CBOE:SPX 's highs from the end of 2021, start of 2022. But, we still don't know what the full effect of the current high interest rates are going to be. It's possible the old mechanism where when we finally reach the top for interest rates, right as we get the precipice of rates starting to fall, equities top out and start to sell off shortly thereafter again. For how big and how long? Who knows.
Despite the recent 'skip' from the federal reserve, opting to not hike at the June meeting, the 3 month yield, which typically is what most closely matches/leads what the fed is going to hike to, has in recent days made it look increasingly likely that we see at least a quarter point hike for July. The market probably won't like that news, maybe we get a few red days, but if economy data coming in still looks solid and inflation is showing a slow, steady reduction, it may not be long before the market decides to go back up again. We might even go past the 2021/early 2022 highs this year.
But, eventually, we'll find the top for yields, and I have a feeling a bigger correction for stocks will loom at that point. For right now, seems like a bad idea to go against the bulls. But, keep an eye out for when we finally reach the top in treasury yields, look in particular for the 3 month, fed funds and the 2 year to go sideways. Once all 3 start to go down, pay closer attention to economic data coming in. Also take a look at www.tradingview.com for evidence of lower highs off the lowest point for the current cycle. You see the combination of the two, we may be in for a big correction. Again.
S&P500 vs Yield Curve vs FedFunds vs Unemployment📢 Yield curve inversion alert! Here's what you need to know:
📉 The 10-year minus 2-year yield curve has inverted 📉 This occurrence, where the shorter-term yields surpass longer-term yields, often raises concerns about the economy's health. Historically, such inversions have been associated with impending economic downturns. The inversion of the yield curve is a signal that investors are expecting short-term interest rates to rise above long-term interest rates in the future. This can happen when investors are worried about the economy and are demanding higher yields on long-term bonds to compensate for the risk of a recession.
The inversion of the yield curve has been followed by a decline in the S&P 500 stock index in the past. On average, the S&P 500 has fallen by 10% within a year of a yield curve inversion.
However, it is important to note that the yield curve inversion is not a perfect predictor of recessions. There have been times when the yield curve has inverted, and a recession has not followed.
🔍 Let's compare past inversions:
1️⃣ 2000 .com bust: The yield curve inversion preceded the dot-com bubble burst, signaling an economic recession. The S&P 500 experienced a significant decline, eroding investor wealth. 2️⃣ 2008 financial crisis: Another yield curve inversion preceded the global financial crisis and housing market collapse. The S&P 500 plummeted, leading to a severe recession and widespread financial turmoil.
📊 How does the yield curve inversion relate to the S&P 500? In the past, yield curve inversions have often been followed by stock market declines. While it doesn't guarantee an immediate crash, it serves as a warning sign for investors and may impact market sentiment and investment strategies.
💰 Relationship to the federal funds rate and unemployment rate: A yield curve inversion can influence the Federal Reserve's decisions on interest rates. In response to an inversion, the Fed may reduce rates to stimulate the economy and prevent a recession. The Federal Reserve is closely watching the yield curve inversion and has signaled that it is committed to raising interest rates in order to combat inflation. However, the Fed may be more cautious about raising rates if the yield curve continues to invert.
Additionally, unemployment rates tend to rise during economic downturns associated with yield curve inversions. The unemployment rate is an important indicator to watch. A rising unemployment rate can be a sign that the economy is slowing down. However, the unemployment rate is currently at a low level, which may give the Fed more confidence to raise interest rates.
🔮 Projections for the current yield curve inversion: While it's challenging to predict exact outcomes, historical patterns suggest caution. The current inversion may signal a potential slowdown or economic headwinds. The stock market could face increased volatility, and the Fed may consider adjusting interest rates accordingly. Monitoring unemployment rates becomes crucial as they may rise if economic conditions deteriorate.
Overall, the yield curve inversion is a sign that investors are worried about the economy. However, it is too early to say whether a recession is imminent. Investors should continue to monitor the yield curve and other economic indicators for signs of a slowdown.
⚠️ Stay informed, diversify investments, and consult financial professionals for personalized advice during uncertain times.
The most important chart...What are the conditions we need for a crash?
In my opinion we need to see these conditions coming together before we can say that we are in a crisis environment.
History showed us that before we had a crisis we 1. first saw the yield curve (US 10 year bond yield - 2 year bond yield) inverting.
2. then we saw the unemployment rate rising.
3. the yield curve steepend again.
Then the SPY had a significant correction or a crash.
So currently one of three conditions are active. The inverted yield curve.
Unemployment rate is slowly rising.
The market is still very strong. Don't step infront of a high speed train.
BIGGEST ECONOMIC CONTRACTION OF A LIFETIMEThe comparisons to the beginning of dot com are uncanny.
I compared countless indicators and the current price action is identical to the dot com beginning.
Additionally, the duration of the yield curve inversion is identical and the % of the drop is identical, almost to the decimal.
The current contraction took 5x as long to reach this point as compared with the dot com.
The dot com contraction took 2.3 years to hit bottom from the identified mark.
Scaling the time, this correction could take 10 years (5 x 2) to reach bottom.
We've enjoyed 15 years of a bull market (with some bumps along the road).
Now, we are facing the most inverted yield curve in 40 + years.
Time for the market to pay the piper.
I fear this will be a recession we will share with our children in 20 years
We are only at the start of this.
Yield curve is inverted today - Its implication and attributeWe have an inverted yield curve today - When the near end yields or interest rates is higher than the far end, we have an inverted yield.
What is its implication and any attributes?
To understand the implications of an inverted yield curve, it is crucial to know what a yield curve is and how it works.
A healthy yield curve –
It shows the relationship between the interest rate and the time to maturity of the bond. A normal yield curve slopes upward, meaning that long-term bonds have a higher yield than short-term bonds. This upward sloping curve indicates that investors demand a higher yield to hold longer-term bonds, as they are taking on more risk by locking up their money for a longer time.
An unhealthy or inverted yield curve –
However, an inverted yield curve occurs when short-term yields are higher than long-term yields. This situation indicates that investors are willing to accept lower yields on longer-term bonds, which is an indication of their pessimism about the economy's future growth prospects. Essentially, investors are willing to lock up their money for an extended period, accepting a lower yield, because they expect economic conditions to deteriorate.
Its implication –
i. It is a reliable predictor of an upcoming economic recession. This phenomenon has been observed many times over the years, and every time an inverted yield curve has occurred, a recession has followed. The reason for this is that an inverted yield curve indicates that investors are losing confidence in the economy, which can lead to decreased investment and spending. This, in turn, can lead to a slowdown in economic growth, which ultimately results in a recession.
ii. Another implication of an inverted yield curve is that it can make borrowing more expensive for certain individuals or companies. Banks typically borrow at short-term rates and lend at long-term rates, earning a profit on the difference between the two. However, an inverted yield curve makes this process less profitable for banks, and they may become less willing to lend, resulting in a tightening of credit conditions.
Attribute –
Short-term fixed deposit saver. ie. Keep rolling your 3-month fixed deposit saving or traders trading into the expected volatility.
In conclusion, an inverted yield curve, where the current Fed fund rate and 3-month yield is higher than the 30-year yield, is a rare occurrence in the bond market that has significant implications for the economy. It is a reliable predictor of an upcoming recession and can result in higher borrowing costs for some individuals and companies. Investors should be aware of this phenomenon and take it into account when making investment decisions.
Some reference for traders:
Micro Treasury Yields & Its Minimum Fluctuation
Micro 2-Year Yield Futures
Ticker: 2YY
0.001 Index points (1/10th basis point per annum) = $1.00
Micro 5-Year Yield Futures
Ticker: 5YY
0.001 Index points (1/10th basis point per annum) = $1.00
Micro 10-Year Yield Futures
Ticker: 10Y
0.001 Index points (1/10th basis point per annum) = $1.00
Micro 30-Year Yield Futures
Ticker: 30Y
0.001 Index points (1/10th basis point per annum) = $1.00
Disclaimer:
• What presented here is not a recommendation, please consult your licensed broker.
• Our mission is to create lateral thinking skills for every investor and trader, knowing when to take a calculated risk with market uncertainty and a bolder risk when opportunity arises.
CME Real-time Market Data help identify trading set-ups in real-time and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
Market Analysis: The Coming RecessionIn this post, I will present a market analysis with a focus on recession metrics and indicators. Right now, many of them are sending a recession warning.
Home Prices -
U.S. home prices are surging higher at the fastest quarterly rate of change on record. (See chart below)
This extreme rate of change in home prices is occurring as U.S. 30-year fixed mortgage rates also explode higher at nearly the fastest quarterly rate of change on record. (See chart below)
Additionally, we see in the chart below that 30-year fixed mortgage rates have potentially broken out into a new uptrend on the longer timeframes. The best way to detect trend reversals is by using the Ichimoku Cloud. When the price closes above or below the cloud (the shaded area) it is considered to have "pierced" the cloud. Once the cloud is pierced to the upside, resistance becomes support. In this case, assuming the piercing sustains, we can see a sustained period of higher interest rates on 30-year fixed mortgages.
Exploding home prices and exploding mortgage rates occurring simultaneously is unsustainable. Examine the yearly chart of U.S. home prices below and notice the similarities between 2005 and 2022. Notice that the Stochastic RSI is extended to the upside, and that home price extends above the upper Bollinger Band. Looking at this chart one could reasonably conclude that in the coming years home prices are likely to revert to the mean (orange line), as they did during the Great Recession.
Many analysts try to contradict what this chart is suggesting by claiming that we are in much better shape now than during the sub-prime mortgage crisis prior to the Great Recession. But are we really? With spiraling inflation, every mortgage holder suddenly becomes relatively more sub-prime. We also did not see mortgage rates explode then as quickly as they are now.
Unemployment -
Analysts point out that the current low unemployment is a reason to believe a recession can be averted. But under the surface, that's beginning to change in a hurry. Below is a chart of most leading unemployment data published by the Federal Reserve: Seasonally Adjusted Initial Claims (Weekly).
In this chart, we see that in about a period of the past 4 months, the amount of new unemployment claims has risen by around 100,000 or about a 50% increase. Compare this to the chart from the 2007-2008, when the U.S. economy was beginning to enter a recession (the shaded area represents where the recession began):
In the period leading up to the Great Recession, we saw a rise of about 50,000 new unemployment claims or about a 15% increase over a similar 4-month period. Therefore, the rate of increase of initial unemployment claims (both in real numbers as a percentage) is higher now than when we entered the Great Recession.
Perhaps more worrisome is the difference in how accommodative the Federal Reserve was in response to rising unemployment. Here is how the Fed Funds Rate changed as unemployment began to rise in late 2007 into 2008:
As unemployment was rising, the Federal Reserve began to cut interest rates. Compare this to the current situation in the below chart which shows the Federal Reserve raising interest while unemployment is rising. This change in context is reflective of both the fact that the Federal Reserve is behind the curve with containing inflation and the fact that the Federal Reserve is prioritizing the current problem (inflation) at the expense of the future problem (unemployment).
We are experiencing a macroeconomic situation whereby rapidly rising initial unemployment claims are being paired with rapidly rising interest rates. This combination is unlikely to end with any other outcome than a recession.
For more details on unemployment data see here: www.dol.gov
To interact with the initial unemployment claims data on a weekly basis you can go here: fred.stlouisfed.org
Yield Curve Inversion -
The 10-year minus the 2-year Treasury yield is used to detect an impending recession. When the 2-year yield rises above the 10-year yield that creates a yield curve inversion, which can often indicate that a recession is coming. Right now the yield curve inversion is very steep. In fact, just recently, the yield curve inversion actually steepened to a level that was even worse than what we saw before the Great Recession.
Perhaps most alarming are the rates of change in interest rates. Look at the 10-year yield Rate of Change on a 3-month basis:
Here's the 2-year yield rate of change:
The federal reserve uses the 10-year minus the 3-month as a more reliable indicator for detecting an impending recession than the 10-year minus the 2-year. However, the rate of change for the 10-year yield has been so parabolic to the upside that the 3-month yield has been struggling to invert relative to it. However, that may soon change. Here's the 10-year minus the 3-month yield chart:
Volatility -
As you know, volatility is measured by the VIX. The yearly Stochastic RSI for the VIX is trending upward, signally the potential for greater volatility now and throughout the years ahead.
This part is a little confusing, but try to follow if you can: Volatility of volatility is measured by the VVIX and is considered a leading indicator of the VIX. Currently, the VVIX is so suppressed to downside that the K value of the Stochastic RSI oscilator has reached zero for only the second time ever. (The first and only other time this has happened was in 2008). While this may be more coincidental than predictive, it nonetheless suggests that volatility of volatility has nowhere to go but up. See below.
Margin -
Margin has already unwinded both in real numbers and as a percentage by a magnitude that is consistent with, and usually only occurs during, a recession. See chart below.
Credit to Yardeni Research, Inc. You can view their full report here: www.yardeni.com
Stock Market -
Several bellwethers in the stock market are showing that, while we may have a robust rebound from extremely oversold levels in the short term, the longer timeframes look quite bearish, especially for the interest rate-sensitive tech and growth sectors.
For more details, here is my analysis on the QQQ/SPY relative performance:
Tech and growth are not alone in the bearish context. Indeed, the bull run from the end of the Great Recession to the current period has been characterized by increasing prices but decreasing volume. This is generally bearish, and may reflect that quantitative easing was a large cause of the bull run. Now, quantitative easing is ending in the face of spiraling inflation.
Other Metrics -
There are many other metrics that are used to detect recessions (e.g. GDP, PMI, M2V). Some may even look toward shifts in demographic trends, rising geopolitical tensions, declining globalization and climate change as recessionary factors. While I cannot discuss every possible metric, one last metric worth considering is the corporate bond market.
In 2020, during the COVID-19 shutdown, in order to stabilize markets, the Federal Reserve rushed in to save corporate bonds from crashing fearing that high borrowing costs for corporations could cause liquidity issues. Corporate liquidity issues can cause a whole host of issues from bankruptcies to layoffs. Currently, however, corporate bond prices have fallen to nearly that of the COVID low when the Federal Reserve rushed in to buy, yet the Federal Reserve is only just beginning quantitative tightening and just now beginning to roll bonds off its balance sheet.
Finally, I will leave you with this note: The time-tested winning strategy is to continue contributing as much as possible to your retirement fund. If the stock market crashes, do not stop or lower your contributions or try to pull money out because you think the world will end. Rather, continue to contribute as much as you can afford no matter what to a retirement mutual fund with diversified holdings. Contributions during market downturns will buy you more shares of your retirement mutual fund relative to the number of shares your contributions bought prior to the market crash. When price rebounds (and it will) you would have been glad to stick to this investment strategy.
