Macro Monitor
Yield Curve Inversion—Count Down To A Bull Steepener
Now that the yield curve has inverted, its dynamic is apt to change from bear flattening (higher rates, flatter curves) to bull steepening (lower rates, steeper curves) fairly soon.
Recession Dashboard Update—Real Recession More Likely Than Not
Our recession indicators have continued to deteriorate. Given the stagflation backdrop, the Fed’s tightening cycle is very likely to end in a recession.
Risk Aversion Index: Stayed On “Higher-Risk” Signal
The risk of a policy error is extremely high as the Fed stays on an aggressive tightening path even with the U.S. in a “technical” recession. Caution is recommended.
Additional Factors
The six-week rally that started mid-June featured advances from AAPL (+25%), AMZN (+30%), and TSLA (+39%), which accounted for one-fourth of the S&P 500’s gain. Despite the recent preference for Value, a spike in interest rates, and the bear market, the index’s concentration in the top-five firms is still near it’s all-time high set in August 2020.
Bond Yields - More Room on the Downside
We have seen the high in bond yields this year and expect a volatile grind lower in rates over the summer: Bearish Treasury positions remain significant, the Copper/Gold ratio fell sharply, and the Citi Economic Surprise Index implies more downside.
Fed Pivot Watch
The late 2018 policy error and subsequent pivot of Chairman Powell’s rookie year is probably the best case-study for today’s pivot debate. Here we evaluate the current status of key pivot triggers and compare them to the readings of late 2018. Given the political environment and backward-looking nature of the Fed, we think the bar is higher for a pivot than the market hopes.
Risk Aversion Index: Stayed On “Higher-Risk” Signal
The risk of a policy error is elevated as the Fed stays on an aggressive tightening path even though growth materially slows. Caution is recommended.
From Tighter Lending To Margin Pressure
Intuitively, what happens in the credit market is usually echoed by lending activities. This was a key concern when the credit market joined the stock-market rout in May. Another big leg up in real interest costs, through higher rates and/or lower growth, will surely create more headwinds for profit margins.
Recession Dashboard Update—More Warning Signs
Overall, there are now more warning signs, but it still doesn’t suggest a recession is imminent.
Risk Aversion Index: Stayed On “Higher-Risk” Signal
While inflation might have peaked, a material slowdown looks more certain as the Fed stays on an aggressive tightening path. Caution is warranted.
U.S. Dollar—Drivers & Impacts
Most U.S. dollar drivers point to a stronger dollar: attractiveness of U.S. assets; policy differentials; real interest-rate differentials; terms of trade; weaker Yuan; and capital flows/hedging activity. Speculative positioning, however, is a negative and suggests the dollar rally might at least take a pause in the near term.
Risk Aversion Index: A New “Higher-Risk” Signal
As long as the Fed stays on the current aggressive tightening path, caution is highly recommended.
Yield Curve—Focus On More Reliable Themes
Predicting a recession is a very tall task, let alone using a single yield-curve indicator with long and highly variable lead time. Instead, we would rather focus on some of the more reliable themes: The macro-policy setting; U.S. dollar; and Bank stocks.
Recession Dashboard Update—Recession Not Imminent
Currently, the dashboard shows 6 green, 3 yellow, and 2 red lights. The overall message is that, while there are areas of concern, a recession is unlikely to be imminent (within the next twelve months).
Risk Aversion Index: Stayed On “Lower-Risk” Signal
With the Fed still on a tightening path, caution is still recommended. Among fixed income, we remain neutral on TIPS but have turned favorable toward EM bonds.
Yield Curve Crossing The 50-Bps Rubicon—No Imminent Trouble
The U.S. 10/2-year curve just fell below the key threshold of 50 bps. Over the last 25 years, the yield curve proceeded to invert after this “Rubicon” was crossed. That doesn’t mean imminent trouble. The lead time of a yield-curve signal is lengthy, but it—and real yields—definitely warrant close monitoring.
Risk Aversion Index: A New “Lower-Risk” Signal
Despite continued weakness in equities and a higher reading in our Risk Aversion Index (RAI), it generated a “Lower-Risk” signal.
Not All “First Hikes” Are Equal
The market has started to price in a much faster pace of the Fed’s tightening this year. We have found more similarities than differences between recent market action and the historical patterns around the first rate hike.
Risk Aversion Index: Stayed On “Higher Risk” Signal
Lofty valuations amid shrinking liquidity conditions make all risky assets vulnerable.
2021 Surprises & 2022 Time Cycles
Market revelations were certainly not in short supply in 2021. We believe some of those surprises will continue to have a huge impact on markets in 2022. We have updated our time-cycle composites to provide an idea of what a “typical” 2022 could look like.