by Franklin J. Parker, CFA
The Summary
- The Bottom Line. After an initial bounce, markets have faded just a bit with questions about whether the Fed will acknowledge the lower-than-expected inflation data. Hawkishness seems to pervade, and Powell has repeatedly said that he would rather over do it than under. By my read of the economic data, there is a storm brewing on the horizon, but the economy has yet to enter a dangerous recession. Caution is warranted, but it appears pessimism is dominating, which may offer some opportunities.
- OPEC is considering increasing their oil production significantly, sending oil prices lower. This would alleviate a lot of pain in prices, both in the US and especially in Europe. Lowered energy costs also gives consumers a bit of a boost, and just in time for the Christmas shopping season. Moreover, lower energy prices should help push down inflation figures, adding some fuel to the “central banks can slow down” narrative.
- Expect a light trading week this week, and a return to business with reports on Black Friday shopping and retailers taking the spotlight next week. This week, durable goods orders will post and global manufacturing PMIs. Both will be watched, but they are unlikely to move markets much.
The Details & Chart of the Week
One of the most reliable indicators of a pending recession is the yield curve.
I specifically look at the difference between yields on 10-year US Treasury bonds and 3-month US Treasury bonds. In a normal environment, you get paid more to tie up your money for 10-years than you do for 3-months, but leading into a recession that relationship inverts. This week’s chart plots the difference between the two.
As you can see, over the past week, the yield curve has inverted and inverted quite strongly. When coupled with everything else, this is a signal that a recession may be beginning to develop.
However, a careful observer will note that it is not the inversion per se that signals the recession. Rather, it is the recovery from that inversion that signals a recession is imminent. In past recessions, the curve reverts about 3 to 10 months prior to the official start of the recession, meaning we have some time to sit and wait.
The point is: caution is warranted, but the current level of pessimism may be overdone.
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