Bitcoin - Another sign that Fed credibility is waning.A Sick Feeling in the Belly of the Yield Curve
Another sign that Fed credibility is waning.
The socioeconomic point of view is that, as the Supercycle bear market develops, central banks will lose their mantle as being omnipotent directors of markets. Whereas in the bull market, central bankers like Alan “the Maestro” Greenspan were lauded because positive social mood was driving the stock market higher, in the bear market central bankers will be vilified as negative social mood causes a downtrend in stock prices.
Yesterday, Fed Chairman Jerome Powell sought to reassure Americans that the series of interest rate hikes that the central bank is embarking on would not tip the U.S. economy into recession. The bond market promptly ignored those soothing words and the yield curve flattened. A flattening yield curve, whereby the positive gap between short-dated bonds and long-dated bonds is narrowing, is a sign that the market is anticipating slower economic growth. When the yield curve inverts, with long-dated yields below short-dated, it has historically been a signal that an economic recession is on the horizon.
That historical relationship is most generally related to the yield spread between 2-year yields and 10-year yields, and that yield curve has been flattening over the past year from 1.50% to around 0.20% where it is currently hovering. So, not quite inverted yet, but trending in that direction.
However, in the so-called belly of the yield curve, the area between 5 and 10-year maturity, the message is already here. The chart below shows that the yield spread between 5 and 10-year U.S. Treasury yields has declined precipitously over the last year and, yesterday, turned negative. This yield curve inversion is a clue that a 2-yr /10-yr (2s 10s in industry vernacular) inversion is probably on its way.
Despite what the Fed says, a beast of a recession may be approaching.
U.S. Treasury 10-Year Yield Minus 5-Year Yield
Yieldcurveinversion
Recession Now Well Underway The yield curve is now fully inverted after reaching EXTREME levels. With that, we can conclude the recession has officially contaminated the financial sector.
Soon (likely before year end) we will see a significant selloff in equities.
Suggest: sell stocks & buy US Treasury Bonds.
Front-Running Yield Curve Normalisation on Rate Cut AnticipationThe (in)famous Yield Curve remains inverted. In recent past, spreads normalized only to revert to inversion as rate cut expectations got pushed out. This time though, is different.
Recent CPI print has significantly altered market sentiment. The likelihood of an initial rate cut at the September FOMC meeting now exceeds 90%. Consequently, the yield curve is normalizing once more. Current market signals indicate that this normalization could be enduring.
WHY IS THE YIELD CURVE INVERTED?
The present yield curve inversion indicates that investors do not expect that rates will remain this elevated for long. While 2Y treasuries continue to be re-issued at higher rates, expectations for longer terms such as 10Y and 30Y are lower as they factor in that rates will normalize from their present levels.
YIELD CURVE WILL NORMALIZE SOON, WHAT WILL DRIVE IT?
While this is the longest period of yield curve inversion in history, the curve has started to normalize. The factors driving normalization in the yield curve were previously discussed. Ordinarily investors demand higher rates for longer-duration treasuries to account for the higher inflation expectations and greater risk.
Either inflation must fall, or inflation adjusted treasury yields for longer maturities must rise.
Rate cuts will also drive the normalization in the yield curve. The yield spread between 2Y & 10Y treasuries tends to rise in the two months preceding the first rate cut in a cutting cycle as observed in the past.
The impact of rate cuts on the 2Y-10Y spread is even more pronounced in the two months following the first-rate cuts.
UNCERTAINTY IN MACRO ECONOMIC DATA IS DISSIPATING
Make no mistake, the broader picture remains uncertain. However, recent data points to recovery. Chicago PMI showed a sharp recovery in July. But the job market signals uncertainty.
Continuing jobless claims remain elevated. Job openings have fallen. But job creation in the last two non-farm payroll prints were above expectations.
US Retail sales and industrial production have improved. The impact can be observed through the consistent increase in the GDPNow forecast for Q2 GDP since 12/July.
Source: GDPNow
The June CPI release showed uncertainty easing. Headline CPI cooled sharply as it fell on a MoM basis. Notably, the stickier core CPI also continued to cool as it fell to 3.3%. However, inflation remaining sticky at the 3% level remains a grave concern.
Even if a recession does arrive in the coming months, the 10Y-2Y yield spread is likely to have normalized by then. Yield curve inversion is observed only before recessions not during.
RAPID RATE CUTS EXPECTED IN THE COMING YEAR
Source: CME FedWatch
The rate cuts outlook has improved substantially. FedWatch signals that rates will fall by 100 basis points by March 2025 (as of 19/July) suggesting successive cuts.
Other analysts are even more optimistic. Analysts at Citi bank hold the view that rates will be slashed by 200 bps (2% in total), starting in September across eight successive FOMC meetings (25 bps at each) by the summer of 2025.
CERTAINTY IN RATE OUTLOOK SUGGESTS YIELD CURVE NORMALIZATION
Major moves in the yield curve have only come through after commencement of rate cuts in the past. This time, markets may front-run these expectations.
The attempts to front-run rate cuts were already observed in December when the yield spread recovered sharply after the Fed signaled six potential rate cuts in 2024.
Presently, the 10Y-2Y yield spread is trading below those levels and has the potential to break out as we approach September rate cuts. The risk of a reversal remains but it is lower.
Higher rates pose a systemic risk for the US given its profligate borrowing. Higher rates on treasuries are untenable for much longer.
Cost of servicing public debt in June hit USD 140 billion and totaled USD 868 billion in the first nine months of the current fiscal year (33% higher YoY). For reference, the total budget deficit for this period was $1.27 trillion. The interest burden is weighing heavily on the overall budget deficit.
HYPOTHETICAL TRADE SETUP
Treasury auctions are a sound guide to maturities selection when positioning for yield curve normalization.
The recent demand for treasuries at the latest auctions has been low. Bid-to-cover ratio for all (2Y, 5Y, 10Y, and 30Y) was lower than the average bid-to-cover over the prior ten auctions. Demand was weak for the 10Y treasuries. Demand for 30Y treasuries has also been lower than previous auctions but has remained more consistent than 10Y.
The yield spread between 30Y-2Y treasuries has outperformed the 10Y-2Y spread over the past 2 months.
Investors can seize opportunities from normalization in the 30Y-2Y spread using CME Yield futures. The CME Yield futures are quoted directly in yield with a one basis point change in the yield representing a P&L of USD 10.
As yield futures across various maturities represent the same notional, to calculate the spread P&L is equally intuitive with a one basis point change in the spread between two different maturities also equal to USD 10.
The hypothetical trade setup consisting of long 30Y and short 2Y is described below.
• Entry: -2.6 basis points (bps)
• Target: +25 bps
• Stop Loss: -25 bps
• Profit at Target: USD 276 (27.6 bps x USD 10)
• Loss at Stop: USD 224 (22.4 bps x USD 10)
• Reward to Risk: 1.24x
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.
Long 10Y, Short 2Y on Yield Curve NormalisationWorld's most important and the largest financial market is the US Treasury. Annual issuance of U.S. Treasuries has exploded. A record USD 23 trillion of treasuries were issued in 2023.
This market is experiencing gradual but notable shifts due to the Federal Reserve (Fed) recent tapering of quantitative tightening and the Treasury buyback. Collective impact has led to demand divergence across different maturities.
The yield curve starting to normalize once more. Economic outlook impacts the yield curve. Not only that, the Fed’s quantitative tightening (“QT”) campaign also has an enormous influence.
At its most recent FOMC meeting, Chair Jerome Powell stated that the Fed would start to slow its balance sheet runoff. The runoff results in supply contraction enabling greater demand for long-term treasuries and a subsequent yield curve normalization.
Runoff refers to the reduction in Fed’s balance sheet as they opt to let their treasury holdings mature without renewing them. This activity leads to a supply contraction.
RECENT HAWKISH FED MEETING CAME WITH A CAVEAT
Since 2022, the Fed has been engaged in a QT campaign. Raising rates is its primary tool. Balance Sheet reduction is an additional strategy to manage monetary environment.
The Fed first announced that it would start to reduce holdings of US treasuries at a fixed pace at its May 2022 meeting. The pace of reduction accelerated as Fed stepped up QT. Treasury runoff has continued at a fixed pace since then.
At the April FOMC meeting, Fed announced its decision to slowdown the runoff. In other words, Fed would start to let treasuries to mature at a slower pace.
Starting from the first of June, the Fed will decrease the maximum amount of treasuries that can mature without being replaced from USD 60 billion per month to USD 25 billion.
Fed’s outlook on rate cuts was hawkish. But its resolve to taper runoff is dovish signalling the Fed’s end of QT campaign through balance sheet reduction. Treasury runoff tapering impact will be noticed additional liquidity before rate cuts arrive.
HOLDINGS & RUN-OFF IS AIMED AT LONG-TERM TREASURIES
Fed’s QT via treasury holdings is implemented through the non-renewal of existing holdings.
Crucially, the impact of letting treasuries mature is more pronounced on long-term treasuries than short term ones. As short-term treasuries mature more often, the impact of this run-off on near-term treasury demand is limited.
In contrast, the impact on long-dated expiries is more pronounced. Analysing the cumulative run-off since May 2022, the largest impact on long-term treasuries has been on 5 to 10 years category which consists primarily of 10-Year notes. This run-off has been particularly high over the last few months. On the contrary, the holdings of 10+ year treasuries have increased.
Source – Federal Reserve
TAPERING RUNOFF SUGGESTS IMPROVEMENT IN LONG-TERM TREASURY DEMAND
Impact on benchmark 10-Year treasuries will be most pronounced as the Fed moves to slow the pace of its runoff. Longer maturities have lagged near-term ones at recent auctions. It was most apparent at the latest auctions.
The 10-Year treasury auction raised USD 42B, that is far higher than the average over the last twelve auctions at USD 31B. While the bid-to-cover was higher than the previous auction in April, it was below the average over the last twelve auctions. Indirect bidding was below average at 65.5%. Overall, this suggests an unimpressive result.
In sharp contrast, 3-Year treasury auction showed strong demand. It raised USD 58B, the highest since 2021. Bid-to-cover was higher than the last auction. Non-dealer bidding was also above average at 85.1% (81.7% average). Similarly, the Treasury 5-Year auction raised USD 70B with an above average non-dealer bidding. Both 3-Year and 5-Year auction results were much stronger.
As observed through the CME TreasuryWatch Tool , the demand for 2-year treasuries has been noticeably higher, as suggested by the bid-to-cover ratios, compared to 10-year and 30-year treasuries.
Source – CME TreasuryWatch
FED’S TAPERING TO FUEL 10Y SPREAD TO OUTPERFORM 5Y SPREAD
Yield curve is normalizing once more following the decline in the 10Y-2Y spread at the start of 2024. This trend is likely to continue as yields for longer dated maturities rise higher than near-term maturities.
Mint Finance highlighted previously that the 5Y-2Y spread is likely to outperform the 10Y-2Y spread. However, as Fed starts to taper its balance sheet run-off, the impact is likely to be felt strongest at the 10Y maturity allowing demand for these treasuries to rise once more.
HYPOTHETICAL TRADE SETUP
Fed’s balance sheet runoff slowdown and the underperformance of the 10Y-2Y spread relative to the 5Y-2Y spread, the 10Y-2Y spread has potential outperform in the near term as the yield curve turns to normalcy.
To harness gains from this normalization, investors can opt to execute a spread trade consisting of Yield futures.
CME Yield futures are quoted directly in yield with a one basis point change in the yield representing a P&L of USD 10. As yield futures across various maturities represent the same notional, spread P&L calculations are equally intuitive with a one basis point change in the spread between two separate maturities also adding up to a P&L of USD 10.
• Entry: -32.3 basis points
• Target: -28.3 basis points
• Stop Loss: -35.3 basis points
• Profit at Target: USD 400
• Loss at Stop: USD 300
• Reward to Risk: 1.3x
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.
RECESSION PROABILITY SIGNIFICANTLY INCREASES JAN - JUN 202410Y/2Y Yield Spread & Unemployment Rate
Originally shared back in July 2023 (see below charts)
Its interesting to see that the yield curve is rising fast (up towards the 0 level)
We are reaching into dangerous recessionary territory. No guarantees, just a significantly increased probability.
Continuous jobless claims are reaching pre-recession warning levels in both time and volume. Meaning more and more people are becoming unemployed and remaining unemployed for longer. More info in links below.
The average interest rate pause timeframe is closing in fast at June 2024 also(Contained in Charts below also).
Its time to pay very close attention. The initial 6 months of this year
Stay safe out there
PUKA
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:
The NASDAQ and Yield Curve Inversion Battle PlanTL:DR
The NDX & Yeild Curve Inversion Pattern suggests that price is bouncing very technically and logically at a long term support trend line. The bubble phase will be complete when price action gets a lot of "white space" between itself and the trendline and the yield curve inverts again in about 2 years.
Introduction
There is definitely a lot of uncertainty in the market and lots of divergent and conflicting opinions. Lots of conflicting news as to why price could go up, down, or sideways. Ideally TA is suppose to help people see through the noise to make rational decisions in the moment you find yourselves in. A lot of this is pattern recognition and probabilities and sometimes, trite sayings to reenforce deeper lessons.
Some of the first trite trading sayings sayings you could have been exposed to:
The trend is your friend until the end
So long as the music is playing keep dancing
bulls make money, bears make money, pigs get slaughtered
Lets keep those in mind going forward
analysis
There are several stages to a bubble and adept traders and investors will be able to negotiate the market with some understanding of what phase the bubble is in. Generally, there is a fair value stage of the bubble and I have that in the orange channels on the NDX and orange zones in the yield curve portion of the chart.
Both orange zones go on for about two years and show lots of uncertainty or even chaos in the financial markets. The late 1988 to mid 1990 saw the end of the Saving and Long Crisis which was a pretty serious event. Looking back the dollar amounts seem relatively small compared to the money that is sloshing around now. The 2005 to 2008 yeild curve inversons kicked off the 2008 financial crisis and it took years for the NDX to return to the swing high of the yield curve inversion.
Eventually the uptrend increases its angle of assent and the blue trend line appears. This becomes our long term support and so long as price action stays pretty close to the trend line the bubble can inflate for years. During this time yield curve inversions drive price action back down to the blue trendline. So long as the trendline holds you have a very logical reason to buy. The music is still playing and the trend is your friend until the end. There are many pull back systems you could use to buy the dip technically.
Below is the NDX on the weekly with the 200 EMA. Every time it has hit the 200 EMA since 2010 it has been an outstanding buy. It is super easy to set stops down there as well. Whether you like that or not it is a very technical buy and very justified. You can buy dip bearing in mind that "Bulls make money.... pigs get slaughtered"
The blow off phase of the bubble occurs when there starts to get a lot of white space between the blue trendline and price action. Once that happens you know that price is going to go below that level because that is how bubbles work.
Quite frankly, when I see the white space and the yeild curve inverts again it is basically time to close longs within the next 30=60 days. There may be some more upside but it will be at the end of a bubble, no point in being to greedy and holding to long.
Generalizations
I see the United States stock market going crazy for the next two years to the upside and then crazy to the downside for another two years. I don't see precious metals having their run until after a lot of the damage from the NDX bubble pop happens. Gold futures bottomed about halfway through the NDX bear market and i think it would be fair to see that happening again.
I see crypto going crazy to the upside along with NDX and then having an even crazier downside and that would be the first true bear market for crypto that occurs with a NDX bear market. There is going to be a lot of pain and misery and lots of projects getting the Luna treatment. My linked idea on the XABCD Butterly will show that disaster scenario.
My trades
I have taken a shining to a couple of cryptos, some new and some old. I still like DASH, DAOUSDT looks good, Kadena looks great. I hope to beat as much money out of these coins while the music is still playing and then hopefully get out before the financial market seizes up again. I think that if things go well for 2 years and my targets get reached before then should be able realize the gains before any catastrophe makes my funds unavailable. Last thing I want is my trades and equity be used to "bail in" the exchanges so they don't have to pay me out.
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.
Recession Timeframe Horizon Macro Monday (2)
Potential Recession Time Horizon
Below you will find a breakdown of how many months pass before a confirmed Economic Recession (shaded grey areas) after the yield curves first definitive turn back up towards the 0% level:
1) 13 Months (Dec 1978 – Jan 1980)
2) 9 Months (Nov 1980 – July 1981)
3) 16 Months (Mar 1989 – Jul 1990)
4) 12 Months (Mar 2000 – Mar 2001)
5) 22 Months (Feb 2006 – Dec 2007)
6) 6 Months (Aug 2019 – Mar 2020)
7) 4 Months so far (Mar 2023 - ????)
Average Time frame: 13 months (reasonable time horizon would be 6 – 18 months).
I consider the first definitive turn up towards the 0% level as no. 7 on the chart (March 2023). Since this date we have rolled over below the -1% level (see additional chart in comments). March 2023 appears similar to the bounce in Dec 1978 (No. 1 in the chart), it also rolled over to the lower sub -1% level. If we assumed a similar 13 month timeframe to recession commencement as in Dec 1978 of 13 months, which also aligns with our 13 month average above, we would be looking at April 2024 for a recession to commence. Interestingly 1978 - 1980 was a similar peak inflationary period known as the Great Inflation, a defining macroeconomic period of high inflation.
You might be wondering, has a recession ever occurred in the month of April before? I personally thought this was a strange month but it has occurred in the past.
In April 1960 a recession commenced and lasted 10 months to February 1961. The 1960 recession was mainly a result of an over-tight monetary policy whereby the Federal Reserve raised interest rates from 1.75% in mid-1958 to 4% by the end of 1959 and maintained them at that level until June 1960. The Federal Reserves motive for raising interest rates and maintaining them was fear of high inflation (as in early 1951 inflation soared to +9.5%). Is it just me or is this all starting to sound a little too familiar?
If we wanted to cater for all time scenarios in the chart and noted above (no. 1 - 6) we could argue that the start of a recession is possible at the earliest within 6 months (Sept 2023) and at the latest 22 months (Jan 2025). Also, the month of April 2024 has some eerie similarities to two prior recessions, the 1978 and 1960 Recessions.
Lucky 13
Since World War 2 bear markets have on average taken about 13 months to reach their bottom and a further 26 months to recover their losses. Our average time before a recession would start is 13 months. It’s worth remembering that it could take an additional 13 months before a bottom is established and then 2 years or 26 months (2 x 13) of price action below the pre-recession price highs. Over 3 years is a long time to wait to recover losses. It would be pertinent to start deleveraging or increasing your hedge from the 6 month mark (Sept 2023 in this case) as subsequently the likelihood of a 3 year period below the Sept 2023 price levels increase as each month passes. For reference the S&P 500 index has fallen an average of 33% during bear markets over the avg. timeframe of 13 months to the bottom.
I actually find it very hard to accept that a recession is possible in the near term (within 6 - 12 months) and I would in fact argue against it, however I cannot explain away the data in the chart which speaks for itself and warrants at least some consideration & caution. Nothing is a guarantee and maybe this time it will be different, especially factoring in the amount of unprecedented liquidity added to the market in recent years, sticky inflation and financial supports provided to systemically important banks.
All the chart really indicates is a probable window for a recession to start some time between Sept 2023 – Jan 2025 and no guarantees.
The rule of 13 is worth remembering, simply from a timing perspective (before and during a recession) as it may help your timing. Based on two similar periods in history, the 1978 and 1960 recessions suggest the month of April 2024 may be a key date. Again, no guarantees.
It is also worth noting that for the last six recessions, on average, the announcement of when a recession started was up to 8 months after the fact…meaning we will have no direct indication when a recession starts, however the un-inversion of the yield curve (back above the 0% level) and a rise in unemployment will be the early tells, so these are worth paying attention too. We will keep you posted on any sudden changes in these metrics.
I hope the chart is helpful, provides one perspective of which there are many, and can help time and frame the situation we currently find ourselves in. NO GAURANTEES, just probable timeframes that may be worth paying attention too.
PUKA
List of Recessions:
1. COVID-19 Recession (February - April 2020)
2. The Great Recession of 2008 (December 2007 - June 2009)
3. The September 11 Recession (March - November 2001)
4. The Gulf War Recession (July 1990 - March 1991)
5. The Iran/Energy Crisis Recession (July 1981 - November 1982)
6. The Energy Crisis Recession (January - July 1980)
7. The Nixon Recession (December 1969 - November 1970)
8. The “Rolling Adjustment” Recession (April 1960 - February 1961)
9. The Eisenhower Recession (August 1957 - April 1958)
10. The Post-Korean War Recession (July 1953 - May 1954)
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
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
What if....
what if we have a yield curve that hasn't been inverted this much in 40 years
what if we've enjoyed 15 straight years of bull markets
what if this is just the start of the correction
what if I told you that I've tested 50 indicators and identified that this correction (on a weekly scale) thus far has matched identically to the START of the dot com bubble (on a daily scale)- March 2000 to June 2000
what if I told you that if you scale the duration of start of the dot com crash to this correction, this correction would be 5.9 X the duration of the dot com bubble and this correction will end it 4.5 years.
I'd encourage you to examine the start of the dot com bubble from March 2000 to June 2000 (daily scale) and compare to the current weekly Nasdaq technicals and see for yourself.
I hope this isn't the case, but what if...
Good Luck
What’s next for Gold & S&P 500?Having covered Gold & the Equity Index last week, this week we will look at how we could leverage both to trade on the move we’re watching!
Quite a happening market we first covered Gold two weeks ago.
Firstly, the interest rates market had a sizeable correction, with the 10Y-2Y yield now trading at close to -0.45% instead of the -1% range just 3 weeks ago.
Secondly, with FOMC out of the way, we have some clarity on what the Fed thinks of the current bank contagion episode as well as how markets reacted to the Fed’s statement.
With all these in mind, one thing we want to point out is the relationship between yield curve inversions across the different tenures of the curve. Comparing the past 2 episodes of yield curve inversion on the shorter and longer end of the curve, we note a few things here.
Firstly, the 10Y-2Y inversion generally leads the 2Y-3M inversion. Secondly, the past 2 times when both sections of the curve were inverted, we saw a significant sell-off in equities happening soon after. Thirdly, the inversions also marked the start of the next leg up for gold.
With peak inversion likely to pass for the 10Y-2Y curve and 2Y-3M inversion at the all-time low now, we see some potential to buy Gold and sell Equity Indices, as we’re raised over the past 2 articles!
When we use the S&P500 Futures Contract and the Gold Futures contract to view the ratio of the S&P500 / Gold, this ‘Selling’ point becomes clearer!
With the past 2 periods falling 59% and 69% respectively and lasting more than 700 days, this trade could take a while to play out, but the risk to reward seems attractive.
As to the hypotheses of why this relationship might exist, it could reside in the idea that abrupt rate cuts likely merely take place in a time of financial distress, hence the selloff in equities and flight to safe-haven assets like gold. When rates fall off, the non-yielding assets like Gold would start to look more attractive to yield-hunting investors, which could have added fuel to the Gold rally, too.
Taking a conservative target of 35% lower from the current ratio level of 2, we position a short in the S&P 500 / Gold ratio by selling 1 S&P 500 Futures and buying 1 Gold Futures, at the current price of 1980 for CME April 2023Gold Futures (GCJ3) and 4010 for the CME June 2023 (ESM3 ) S&P 500 Futures, the notional value of the position for the long & short leg is almost equal at;
Long GCJ3: 1980*100 = 198,000
Short ESM3: 4010 * 50 = 200,500
Setting up such a spread trade requires some monitoring of the difference in notional value to ensure that the position is properly hedged. Each 0.25-point move in the ESM3 contract is equal to 12.5 USD while a 0.1-point move in the GCJ3 contract is equal to 10 USD. Trading this spread would be eligible for a margin offset of up to 70%, meaning that the capital required to set up this trade is much lower.
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
SP500 vs FedFund vs Unemp vs Yield CurveUS stocks vs the Federal Reserve Funding Rate vs the unemployment rate vs 10yr-2yr treasury yields. When the 10yr vs 2yr yield goes negative it means that a 2yr treasury bond is yielding more interest than a 10yr treasury bond and it is also known as a yield curve inversion. The red vertical lines in the chart are drawn from yield curve inversions which are usually followed by the Federal Reserve lowering interest rates, a rise in unemployment and US recessions. We're currently in a yield curve inversion that has gone more negative than the inversions just prior to the Covid panic, the 2008 financial/housing crisis and the 2000 dot-com bust which were all accompanied by record stock market losses.
Maybe this time will be different...
Interest rates are moving againWhat is moving this week? Our weekly eyeball into the different markets.
Interest rates likely to be breaking its all time high again, get ready for another volatile month ahead.
Difference between yield and interest rate:
Borrowers take reference from interest rates and lenders take reference on the yield. Interest rates and yield moves in tandem.
Minimum price 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.
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
Inflation is plateauing and likely to end flat in 2023Inflation is plateauing and likely to end flat in 2023, so what will that impact the markets?
Though inflation peaked at 9% last year and has been declining to 6.4%, CPI seems to be plateauing and may close flat in 2023, but this is not good news at all. Why? Because the Fed wanted to see the CPI or inflation coming down to 2% in a sustained manner.
Studying across the 2-, 5-, 10- and 30-years yield, we are seeing all the 4 yields almost breaking above its October 2022 all time high again. As long as the inflation remain flat at this current level, the Fed will continue its moderate rate hikes.
Therefore, we are expecting more volatility ahead with a flat inflation number.
This is definitely bad news for the stock investors, but not for the traders. Since 3rd week of 2022, I have exited from my long-term hold for the U.S. stock markets to trading the U.S. indices with much anticipated inflation and volatility.
Also, trading into the Micro Yield Futures. Since it is on an uptrend, I prefer to focus mainly on buy on dip strategy.
CME Micro Years Yield Futures
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.
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
No Landing in the Twilight ZoneCBOT: Micro Treasury Yields ( CBOT_MINI:2YY1! , CBOT_MINI:5YY1! , CBOT_MINI:10Y1! , CBOT_MINI:30Y1! )
Is the US economy heading towards a “no landing”, as opposed to a “hard landing” or a “soft landing"? There is a heated debate among economists and market strategists.
What is a "no landing"? It is a new term drawn up by Wall Street, which describes the economy continuing to grow while the Fed raises interest rates to fight inflation.
Stock investors have a hard time making sense of the latest data from inflation, employment, and corporate earnings. The Fed’s future policy actions are unclear. As a result, the US stock market moved sideways in recent weeks.
Treasury Market in Disarray
With a widening negative yield curve, bond investors are convinced that a US economic recession is on the horizon. Let’s refresh our knowledge on this subject.
Yield curve shows interest rates on Treasury bonds with short-term, intermediate, and long-term maturities, notably 3-month T-Bill, 2-year and 10-year T-Notes, 15-year and 30-year T-Bonds.
Bond investors expect to be paid more for locking up their money for a long stretch, so interest rates on long-term debt are usually higher than those on short-term. Plotted out on a chart, the various yields for bonds create an upward sloping line.
Sometimes short-term rates rise above long-term ones. That downward sloping line is called yield curve inversion or negative yield curve. An inversion has preceded every U.S. recession for the past 50 years. It’s considered a leading indicator of economic downturn.
On July 21st 2022, the 2-year yield stood at 3.00%, above the 2.91% 10-year yield. Since then, we have been in negative yield curve environment for seven months. The 10Y-2Y yield spread has widened to -76.9 bps, but a recession has not yet occurred.
Below are current yields indicated by CBOT Treasury futures as of February 17th:
• 30-day Fed Funds: 4.665%
• 2-year Treasury: 4.618%
• 5-year Treasury: 4.014%
• 10-year Treasury: 3.848%
• 30-year Treasury: 3.883%
We observe that the longer the duration, the lower the yield. The 5Y, 10Y and 30Y yields all price below current Fed Funds rate target of 4.50-4.75%.
The US economy seems surprisingly strong, despite the Fed trying to cool it with eight consecutive rate hikes. However, negative yield curve contradicts the notion of “No Landing”.
Trading Opportunities in Micro Yield Futures
Investors currently expect the Fed to raise interest rates in March and June meetings, with the terminal rate consensus at 5.3% at the end of this tightening cycle.
Clearly, Treasury futures market has not priced in the pending rate hikes. The most underpriced interest rate is the 10-year yield. At 3.85%, it is 90 bps below current Fed Funds target and 1.45% below expected terminal rate.
On February 17th, the February and March 2023 contracts of CBOT 10-Year Micro Yield Futures (10Y) were quoted almost the same rate, at 3.850% and 3.853%, respectively. Investors apparently brushed off the upcoming rate increase in March.
My trading rationale: US businesses continue to expand, which provides solid support for the long-term debt market. With short-term yield rising fast, borrowers would flock to lower rate debt, pushing up demand for the longer-term credit. In my opinion, a 10-year yield below 4% is not sustainable.
For confirmation, let’s take a look at various market interest rates for 10-year duration:
• US Corporate AAA Effective Yield: 4.61%
• US Corporate BBB Effective Yield: 5.64%
• US Mortgage Rate, 10-year fixed: 6.24%
• Bank Certificate of Deposit, 10-year: 4.10% (Discover Bank)
Monthly contracts for the 10Y are listed for 2 consecutive months. Contract notional value is 1,000 index points. A minimum tick of 0.001 (1/10 of 1 bps) is worth $1. This means that a 25-bps increase will translate into $250 per contract. It would be a 77% gain in contract value if we use the $325 initial margin as a cost base.
April contract starts trading on March 1st. If it is quoted similar to the March contract, there is potential to gain. Whether we compare with market rates of debt instruments of the same 10-year duration, or with risk-free Treasury rates of different durations, a 10-year yield pricing below 4% is a bargain. Besides, the FOMC meeting on March 21st-22nd would likely give the contract a big boost, as long as the Fed raises rates. In summary, I would consider a long position for April 10Y contract at or below 4% yield.
What about the idea of yield curve reversal and the narrowing of 10Y-2Y spread? It may still happen, but its timing is unclear at this point.
Micro Yield futures are designed for shorter-term trading with contracts listing for only two calendar months. This is different from CBOT 2-year (ZT) and 10-year (ZN) futures which are listed for 3 consecutive quarters, currently through September. The traditional Treasury futures contracts would be better instruments for a yield spread strategy.
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trade set-ups and express my market views. If you have futures in your trading portfolio, check out on CME Group data plans in TradingView that suit your trading needs www.tradingview.com
The yield curve has to un-invert eventually… right? (Part 2)This week, we thought it will be interesting to review the trade from last week given the reaction post-FOMC, as well as discuss an alternative way to set up this trade.
Firstly, let’s review the post-FOMC/employment data reaction.
- Nonfarm Payrolls surprised to the upside, as over half a million jobs were added way above the estimates of a sub 200K number.
- Unemployment rate continues to fall further, reaching a 53-year low of 3.4%
A clear re-pricing has occurred since last Friday’s better-than-expected jobs data and Wednesday’s Federal Reserve meeting. With markets now expecting 1 more rate hike in May, bringing the peak rate up from the 475 -500 bps range to the 500-525 bps range.
Keeping this in mind, we go back to our analysis last week to understand this situation and historical precedence.
While the time for a pause in rate hike seems to be pushed back, in the grand scheme of things, we think that this has only kept the window of opportunity for this trade open for longer and at a more attractive entry point now.
Without repeating ourselves too much, we encourage readers to take a look at our idea last week which explores the historical correlation between the peaking of yield curve inversion and the pause in Fed rate hikes.
Link to our last week’s idea:
This week, let’s tap into a different instrument. Here, we aim to take a short position on the 2Y-10Y yield differential by creating a portfolio of Treasury futures to express this view.
To do so, we would have to first select the 2 instruments, the 2-Yr Treasury futures is a straightforward choice for the short end. But for the 10-Yr leg, we have a choice of the '10-Yr Treasury Note Futures' vs the 'Ultra 10-Yr Treasury Note Futures'. Digging into the contract specification, the 'Ultra 10-Yr Treasury Note Futures' provide a better proxy for the true 10-year duration exposure as the delivery requirements are for Treasuries with maturities between 9year 5 months and 10 years. In comparison, the underlying of '10-Yr Treasury Note Futures' has a maturity between 6 year 6 months and 10 years.
With contract selection out of the way, the next step is to calculate the Dollar Neutral spread. This requires us to identify the DV01 of the front and back legs of the spread and try to match them. This is to ensure that the entire position remains as close to dollar neutral as possible, so we can get a 'purer' exposure to the yield difference between the front and back legs, and parallel moves are negated. CME publishes articles on this topic to explain the setting up of a DV01 spread clearer than we can explain. You can find them attached in the reference section below.
You can handily find the DV01 of the Cheapest To Deliver (CTD) securities on CME’s website.
In this case, we are looking at the 2Yr and Ultra 10Yr Treasury Futures to set up the trade. With the DV01 of the 2Yr at 34.04 and the DV01 of the Ultra 10Yr at 96.26.
The spread ratio can be calculated as 96.26/34.04 = 2.83. Rounding this to the nearest whole number, we would need 3 lots of2-Yr Treasury Future and 1 lot of Ultra 10-Yr Treasury Future, to keep the DV01 equal (neutral) for both legs of this portfolio.
Given our view of the 2Yr-10Yr yield spread turning lower, we want to short the yield spread. Yield and prices move inversely, hence, to short the yield spread, we long the Treasury Futures spread as it is quoted in price. We can long 3 ZTH3 Futures (2Y Treasury Future) and short 1 TNH3 futures (Ultra 10Y Treasury Future) to complete 1 set of the spread. However, since the 2-Yr Treasury Futures has a notional value of 200,000 while the Ultra 10Y Treasury Futures a notional of $100,000, the price ratio will be 6:1 when the position/leg ratio in the spread trade is 3:1. As such the current level would provide us with an entry point of roughly 494 with a minimal move in Ultra 10yrs representing 15.625 USD and that in 2Y representing 7.8125 USD.
While slightly more complex in setting up, this trade allows us another alternative to express the same view on the yield curve spread differential. Being able to execute the trade via different instruments allows you to pick the most liquid markets to trade or take advantage of mispricing in the markets.
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
www.cmegroup.com
The yield curve has to un-invert eventually… right?Those who have been reading our past 2 ideas will know we’ve been harping on and on about expected rate path and policy timelines. Why the recent obsession you ask? Because we think we’re on the cusp of major turning points.
So, for the third time, let’s look at the market’s expected policy rate path.
With FOMC coming up this week, we are expecting a 25bps hike followed by some commentary/guidance on the next cause of action. Based on CME’s Fedwatch tool, markets are expecting a last hike of 25bps in the March FOMC before a pause in the hiking cycle. Now keep that in mind.
One interesting relationship we can try to observe is how the 2Yr-10Yr yield spread behaves in relation to where the Fed’s rate is. We note a few things here.
Firstly, the ‘peak’ point of the 2Yr-10Yr spread seems to happen right around the point when rate hikes are paused. With the Fed likely to pause as soon as March, we seem to be on the same path, setting up for a potential decline in the spread.
Secondly, the average of the past 3 inversions lasted for around 455 days, and if you count just the start of the inversion to the peak, we’re looking at an average of 215 Days. Based on historical averages, we are past the middle mark and have also likely peaked, with current inversion roughly 260 days deep.
Looking at the shorter end of the yield curve, we can apply the same analysis on the 3M-10Yr yield spread.
The ‘peak’ point of the 3M-10Yr yield spread is marked closer to the point when the Fed cuts, except in 2006, while the average number of days in inversion was 219 days and the average number of days to ‘peak’ inversion was 138 days. With the current inversion at 105 days for the 3M-10Yr Yield spread, we are likely halfway, but the peak is likely not yet in. (Although eerily close to when the Fed is likely to announce its last hike, March FOMC, 51 days away).
Comparing the 2 yield curve spreads, we think a stronger case can be made for the 2Yr-10Yr spread having peaked and likely to un-invert soon.
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. 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, at an entry-level of 0.623, 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
When downside volatility becomes an advantage.It’s been a while since we looked at the Russell 2000. For the uninitiated, the Russell 2000 index is a small-cap stock market index that is made up of the smallest 2000 stocks in the Russell 3000 Index.
The small-cap nature means a few things, volatility tends to be higher for one. And capturing this downside volatility using the Russell 2000 as compared with the S&P 500 has almost always proven more fruitful.
When to take this trade you may ask? The recession bellwether indicator of the 2Y – 10Y yield spread is a simple place to start. With the benefit of hindsight, shorting each of the indexes at the peak ‘inversion’ points proves to be a decently successful strategy. Especially so using the Russell 2000.
So the next question to ask is if we are near the peak point of inversion?
To answer this, we have to circle back to research from last week, where we discussed the expected rate path for the Federal Reserve (Fed).
In short, markets seem to be pricing in a Fed pause, followed by a pivot in the coming year. Looking back at the charts, this shift in stance (or pause) highlighted in the top chart generally marks the turning points for the 2y-10y yield curve inversion, highlighted in the bottom chart. Therefore, with markets expecting a pause as early as the first quarter, we suspect that the turning point for the yield curve inversion is just around the corner.
On price action, the 1900 level proves to be of significant resistance, with multiple attempts to break through being rejected. As prices creep towards this resistance level once again, we think this might just provide another attractive opportunity for trading.
Zooming out to a daily timeframe, the 0.382 Fibonacci levels marked by the previous high and low, also coincide close to the resistance levels on the shorter timeframe.
The proven downside volatility, along with the coming turning point in the yield curve inversion, keeps us bearish on the Russell 2000. Additionally, the price action points to significant resistance overhead, around the 1900 level. Setting our stop at 2035 level (one Average True Range away & close to the next resistance level) and take the profit level at 1690, with each 1-point increment in the Russell 2000 futures contract equal to 50$.
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.
A Grim Picture of InflationFed Funds Futures (ZQ) CBOT:ZQ1! , 2-Yr Yield (2YY) CBOT_MINI:2YY1! , 10-Yr Yield (10Y) CBOT_MINI:10Y1!
This is the third report in the series “Year of the Rabbit: Short-tailed Trading”.
US Consumer Price Index (CPI) declined 0.1% in December 2022 on a seasonally adjusted basis, after increasing 0.1% in November, the U.S. Bureau of Labor Statistics reported on Thursday, January 12th. Over the last 12 months, the headline CPI increased 6.5%. The inflation index for all items less food and energy rose 0.3% in December, after rising 0.2% in November. The Core CPI increased 5.7% year-over-year.
December is the only month in 2022 when aggregate price falls below prior-month level. The headline CPI is now 0.5% lower than a year ago on an annualized basis.
Cooling inflation is welcoming news to consumers, businesses, and investors. It also gives the US Federal Reserve more flexibility to moderate its hawkish monetary policy.
Inflation by Category Data Paints a Different Picture
The December CPI data was a “one-man show”. Gasoline price declined 9.4% in one month, bringing its annual change to -1.5%. After an all-time high record of $5/gallon reached in June, we ended 2022 with lower gasoline price year-over-year.
If you think we are getting relief in energy cost, nothing could be further from the truth.
• Fuel oil dropped 16.6% in December, but it is up 41.5% for the year
• Electricity price went up 1% in December and +14.3% for the year
• Pipelined natural gas were up 3% monthly and +19.3% yearly
Americans are getting bigger utility bills to light up the room and heat the house this winter.
Other essential items:
• Food cost +0.3% in December and +10.4% Y/Y in 2022
• Shelter cost +0.8% monthly and +7.5% annually
• New cars cost 5.9% more but used cars are 8.8% cheaper in 2022
Inflation is certainly on the way down, but it is sticky. Many product and service items essential to household living and business operation are far from under control.
Interest Rate Outlook for 2023
After the release of new CPI data, market consensus centers on a modest 25-basis-point increase on February 1st., which would bring the Fed Funds rate up to 4.50-4.75%. I also expect another 25-bp raise on March 22nd, setting the so-called terminal rate at 4.75-5.00% for the rest of 2023. This is my baseline forecast for 2023.
The previous section shows that inflation is still uncomfortably high for food, housing, and energy to power the home, as well as for new vehicle. The Fed’s job for fighting inflation is far from over. I do not expect any rate cuts to occur in foreseeable future.
When it comes to central bank monetary policy, there is a lagging period before it works its way through the economy. The response lag could be anywhere from 6 to 12 months. By my estimate, it takes about 7 months in this rate-hike cycle.
The Fed initiated the first increase in March, but inflation did not peak until June at 9.1%. Monthly CPI was unchanged the following month. However, the slowdown was solely due to a sharp decline in gasoline price, not attributable to the Fed.
Core CPI topped 6.6% in September, then subsequently moved lower to 6.3%, 6.0% and 5.7% in the fourth quarter. October was the first month when core inflation reverses its rising path. This is where I mark the start of inflation response to monetary tightening.
Once the Fed reaches its terminal rate, the force of inertia would carry the policy impact on inflation for several more months. That’s why the Fed is likely to keep the rate unchanged for the remainder of 2023, measuring the policy effect.
Fixed Income Investment Opportunities
On “The Real Cost of Fed Rate Hikes”, published on July 25th, I spelled out the impact of interest rate increases to households, corporations, Federal and local governments.
With the risk-free rate expected to reach 5%, all borrowing cost will go up further, even after they rose significantly last year. As the economy slows down, those with high debt loads may not make it through this downturn.
If you plan on investing in bonds, default risk should be on the very top of your mind. Consider safe play: Avoid any issuer with a high debt-to-equity ratio. Corporate high-yield, municipal bonds, and securities backed by adjustable-rate mortgages and credit card balance fit this bill.
JPMorgan Chase took notice. On Friday the 13th, JPM NYSE:JPM posted revenue that beat expectations, but the biggest US bank warned it was setting aside more money to cover credit losses because of a “mild recession” is its “central case.” The bank posted a $2.3 billion provision for credit losses in Q4, a 49% increase from the 3rd quarter.
For relatively safe investment options, bank certificates of deposits (Jumbo CD) and high-quality corporate bonds (rated A or above) offer yields from 4.50% to 6.0%. They could beat inflation in the coming years.
Spread Trade Opportunities
We have been in a negative yield-curve environment since July. In my opinion, slower rate hikes weaken the force that drives short-term yield rising faster than long-term ones. Once the Fed actions are over, mean reversion could occur so long as we do not fall into a deep recession.
A Refresher: Yield curve plots the interest rates on government bonds with different maturity dates, notably 3-month Treasury Bills, 2-year and 10-year Treasury Notes, 15-year and 30-year Treasury Bonds.
Bond investors expect to be paid more for locking up their money for a long stretch, so interest rates on long-term debt are normally higher than those on short-term. Plotted out on a chart, the various yields for bonds create an upward sloping line.
Sometimes short-term rates rise above long-term ones. That negative relationship is called yield curve inversion. An inversion has preceded every U.S. recession for the past half century, so it’s seen as a leading indicator of economic downturn.
On January 12th, 2-year T-note is quoted at 4.20% in cash market, while the 10-year T-note is priced at 3.61%. This measures the 10Y-2Y yield spread at 59 basis points.
The negative yield curve could become less inverted, then change to a flat yield curve in the coming months. It could reverse back to an upward sloping normal yield curve in 2024. Here are my reasoning:
• Easy money created by record government spending kept the borrowing cost low. This was a main reason why longer-term yields rise less than short-term ones.
• The new Republican-controlled Congress would stall the approval of big-ticket expenditure bills. Closing the flood gate could bring the borrowing cost back up.
• After the depletion of low-cost capital, lenders will have no choice but to raise the long-term lending rate above the short-term deposit rate.
CBOT Micro Yield Futures offer a way to express your view on future yield direction. You could also observe how the expected yield spread changes between 10Y and 2Y.
On January 12th, February Micro 10Y Yield Futures (10YG3) was settled at 3.446. February Micro 2Y Yield Futures (2YYG3) was settled at 4.081. The 10Y-2Y spread is -63.5 basis points.
Micro Yield Futures are notional at 1,000 index point, with each point equal to 1/10 of 1 basis point and value at $1. For example, if the 10Y-2Y spread narrows to -40 basis points, your position would gain $235 (= (-40+63.5) x 10) if you long the spread.
To trade Micro Yield futures, margins are $375 for 10Y and 2YY. A long spread can be constructed by a Long 10Y and a Short 2YY positions.
Happy trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trade set-ups and express my market views. If you have futures in your trading portfolio, check out on CME Group data plans in TradingView that suit your trading needs www.tradingview.com
Yield Curve Inversion Continues: More Pain Ahead Later?This post will provide a quick macro update concerning the yield curve inversion in US bond markets, which have often (though not always) been followed by a bear market in equities.
Note the various yield curve inversions in the 10-2 Treasury yield. This compares the 10Y US Treasury yield with the 2Y US Treasury yield , and when the 2Y yield exceeds the 10Y yield, the curve inverts (the result of 10Y - 2Y is a negative number).
The yield curve has now become inverted for the second time this year. The inversion is deepening, and it's been 10 consecutive days of inversion territory. The inversion is entering its 3rd week of the 10s-2s being inverted.
This is starting to exceed the inversion in 2005-2006 that lead to the 2 year bear market b/w 2007-2008 and it's approach about 1/2 the depth of the inversion in 2000, which was a severe bear that led to the NDC falling 70% over 2 years.
The chart above allows an easy visual comparison between prior inversions (labeled by date) and the current inversion.
The black line on the chart represents the Nasdaq 100 NASDAQ:NDX , also tracked by the NASDAQ:QQQ ETF traded on US securities exchanges.
The current inversion presages a higher likelihood of more pain in equities and other risk assets . An inversion does not necessarily lead to an immediate market decline as history shows, but it tends to lead to recession, which in turn is associated with extended bear markets (rather than a more minor 1-3 month correction as was seen with the Covid crash in 2020).
There was a minor inversion between the 10s-2s Treasuries in March 2022, 3 months ago, but that one only lasted 2 days. The current inversion has lasted now for about 2 weeks and looks likely to continue.
The current inversion has become more deeply negative than even the 2006 inversion, which presaged a severe-2 year bear market associated with the Great Financial Crisis. But so far, it only approaches half the depth of the 2000 inversion, which presaged a different but severe 2-year bear market that saw the Nasdaq lose 70% of its value (albeit with several powerful multi-week / month bear rallies interposed in between major declines).