While US cash markets are closed today, the rest of the world - as well as US futures - are busy levitating amid renewed optimism that China has finally managed to contain its latest Covid breakdown after Beijing said the outbreak is now under control and the country eased more virus curbs. The upside momentum was also boosted by the best week on Wall Street since November 2020, which was catalyzed by speculation that the Fed will pause its hiking plans in September (and then proceed to ease once the recession is official). At 730am ET, emini futures trade 30 points higher or 0.70%, while Nasdaq futures jumped 1.2% higher. Oil climbed in response to the easing of Chinese lockdowns and as the European Union worked on a plan to ban imports of Russian crude, while the dollar fell for a third day.
While US markets are closed, the S&P 500 wiped out its May losses and snapped a string of seven weekly declines as institutional investors rebalanced portfolios into the end of the month.
“Risk is back in business it seems,” said AJ Bell investment director Russ Mould. “A reopening of key economic hubs in China and suggestions the US Federal Reserve might slow the pace of interest rate hikes are helping to boost sentiment, at least in the short term.”
Traders will be pondering whether the bottom of the selloff is near as investors have been buying the dip after one of the worst starts to the year for equities. However, as Bloomberg notes, a wall of worries remains from hawkish central banks underscoring fears of a recession, escalating food inflation from the war in Ukraine and China’s lockdowns stunting economic activity.
“We are in the middle of a bear-market rally,” said Mahjabeen Zaman, Citigroup Australia head of investment specialists, said on Bloomberg Television. “I think the market is going to be trading range-bound trying to figure out how soon is that recession coming or how quickly is inflation going down.” She added that Treasury yields are set to peak this year.
European bourses enjoyed a fourth day of gains, extending their longest winning streak since late March and driving the Stoxx 600 index to the highest in more than three weeks. Luxury stocks outperformed Monday as China’s reopening plans boosted sentiment. The Euro Stoxx 50 rose 0.9%, with Spain's IBEX lagging, dropping 0.2%. Consumer products, tech and travel are the strongest-performing sectors. Shares in European crypto stock rose as the price of Bitcoin jumped to almost $31,000, as risk-on appetite returns with China easing Covid restrictions.Bitcoin was up 5.2% and trades at $30,660.69 as of 730am ET, set for its biggest gain in two weeks. Stocks such as Northern Data soared as much as 5.1% Argo Blockchain 2.6%, Arcane Crypto +6.3%, Safello Group +2.8%.
Spanish inflation unexpectedly quickened, while regional German inflation data also pointed to a concerning picture ahead, denting hopes that the eurozone’s record inflation surge has peaked and piling more pressure on the ECB to act. German bunds fell the most in two weeks.
Equities across Asia Pacific rose as China rolled back some strict pandemic-triggered restrictions and after US 10-year Treasury yields capped a third week of declines. The MSCI Asia Pacific Index extended gains to 2.1%, the biggest jump this month, led by consumer discretionary and tech shares. Benchmarks in Japan and Taiwan advanced the most. Chinese shares including tech names climbed as local authorities eased curbs on movement in key cities after virus cases fell. The Asian measure is close to erasing losses for May, which would mark its first monthly advance this year as a reopening of China’s economy boosts growth prospects for the region. That, along with stabilizing global bond yields, have supported regional shares. Still, concerns about slowing global growth and high inflation remain, with foreign investors dumping Asia’s tech-heavy markets this year. With US markets closed for a holiday Monday, traders are turning their attention to China’s purchasing managers’ index figures for May, scheduled for release Tuesday.
“The focus will be on how much the May data has improved from April, given the number of cities under some sorts of lockdown” has fallen to 26 from 44, accounting for 20% of national GDP, Charu Chanana, a market strategist at Saxo Capital Markets, wrote in a note.
European bonds tumbled after Spanish inflation came in hotter than expected, while regional German inflation data also pointed to a worrisome picture ahead, with more CPI prints out of the euro area due later Monday and Tuesday. Money markets raised ECB rate-hike bets, pricing 114 bps of hikes by the end of the year. Bunds yield curve bear-flattens, 5y underperforms, cheapening ~9bps to near 0.75%. Peripheral spreads widen to Germany with 10y BTP/Bund widening 3bps to ~195bps. Gilts follow suit, with the 10-year yield up some 6bps to 1.975%. US 10-year note futures decline 12 ticks to 119-24+ with cash Treasuries closed for US holiday.
In FX, the dollar slipped for a third day versus major peers as havens lost their appeal amid the improved mood. The Bloomberg dollar spot index fell 0.2%. JPY and CHF are the weakest performers in G-10 FX, SEK and NOK outperform. China’s yuan outperformed after the nation reported fewer Covid-19 cases in Beijing and Shanghai. China’s reopening moves prompted a gauge of emerging-market stocks to rise to the highest since May 5.
Bitcoin posted its biggest gain in two weeks, climbing close to $31,000, with ethereum regaining $1900.
In commodities, oil climbed as China eased anti-virus lockdowns and the EU worked on a plan to ban imports of Russian crude; Brent is heading for its sixth monthly gain, the longest winning streak since April 2011; US gasoline prices surged to another fresh record. WTI drifted 0.5% higher to trade above $115 while Brent rose above $120.
Spot gold is off best levels, up some $4 to $1,857/oz. Most base metals trade in the green; LME nickel rises 6.5%, outperforming peers.
There is nothing on the US calendar due to the Memorial Day holiday.
DB's Jim Reid concludes the overnight wrap
Everything was going so well at lunchtime on Saturday. In my big 36-hole tournament I was poised and ready to pounce just outside the top ten. However I then had one of my worse rounds for years as my back seized up and then, immediate after, watched Liverpool lose the biggest match of the season. I went to bed wondering if Liverpool could ever recover from this and whether my back would ever allow me to play the type of competitive golf I want to again. It was a low moment. Then in another competition on Sunday my back eased and I shot my best competition round for as long as I can remember. Annoyingly I finished second and missed out on the cup. A bit like Liverpool.
It’s going to be a bit of a stilted week with the US off for Memorial Day today and the UK off on both Thursday and Friday to celebrate the Queen’s Platinum Jubilee. However there’s lot of important data from both a growth and inflation perspective this week with the monthly jobs report from the US (Friday) and a slew of May CPIs from Europe. Industrial activity will be in focus too with the Chicago PMI, the Dallas Fed manufacturing activity index (Tuesday), the ISM index (Wednesday) and several European PPIs due.
On Wednesday, markets will also be especially focused on central banks with the start of the Fed's balance sheet run off, the BoC decision and the Beige Book release. In Asia, next week will be packed with data for Japan and PMIs from China will be due.
Given the recent rally in bond markets, one of the most important prints could be German inflation today with estimates slightly higher than last month which on one measure was the joint highest since 1950. We’ll get the regional prints this morning and then the country wide aggregate at lunchtime. On the EU harmonised reading consensus is at 8.1% up three tenths from those record levels. As we go to print the NRW region in Germany has seen the YoY rate climb four tenths from last month to 8.1%. France, Italy and the Eurozone sees their CPI releases tomorrow.
Producer prices will also be released across the continent, with April PPI due from Italy (today), France (tomorrow) and the Eurozone (Thursday). Finally, labour market indicators will be released throughout the week for Germany (tomorrow), Italy and the Eurozone (Wednesday).
Over in the US, all roads lead to payrolls on Friday with our US economists projecting gains of 325k vs last month's 428k reading that came in above of the median estimate of 380k on Bloomberg. The JOLTS and ADP reports will be due on Wednesday and Thursday, respectively. The JOLTS report is our favourite for looking at labour market tightness but it is a month behind the less useful payroll report.
Another important set of indicators will come for industrial activity, including the Chicago PMI and the Dallas Fed manufacturing activity index tomorrow, the ISM manufacturing index on Wednesday and April factory orders on Thursday. These follow misses on PMIs, the Richmond index and the durable goods orders last week, so markets will be paying attention as to whether these metrics will come in softer than expected as well. Finally, Conference Board's consumer confidence index, tomorrow, will be assessed in conjunction with the labour market data to gauge the strength of the consumer.
From central banks, investors will be awaiting this Wednesday when the Fed is due to start its balance sheet run off in order to gauge the preliminary impact on the markets. Elsewhere, the Bank of Canada's decision will also be due on Wednesday, following a +50bps move at the last meeting on April 13th. Analysts are expecting another 50bps. Finally, the Fed will also release its Beige Book that day and its insights about current economic conditions will be digested together with the other timely US indicators. In speakers, this week, similar to last, will be packed with those from the ECB. Their views in light of the week's CPI prints will be of great importance. Fed speakers are detailed alongside those from the ECB and all the key data releases in the day-by-day calendar at the end.
In Asia, the highlight will be May PMIs for China released tomorrow and Wednesday and much attention will be paid to the growth dynamics after dismal industrial production and retail sales numbers released two weeks ago.
Talking of Asian, stock markets are edging higher at the start of the week following Friday’s gain on Wall Street coupled with a weaker US dollar and fresh stimulus from Beijing. The Nikkei (+1.97%) is leading gains regionally with the Hang Seng (+1.90%) also significantly higher. Over in mainland China, the Shanghai Composite (+0.31%) and CSI (+0.44%) are modestly up after the Shanghai administration announced that it would remove 'unreasonable curbs' on businesses and manufacturers from 1 June to stimulate sagging growth. At the same time, the city unveiled fresh economic support measures by offering tax rebates for companies and allowing all manufacturers to resume operations from June. Among the 50 policy measures in eight categories announced by Shanghai officials the city will cut some purchase taxes, issue more quotas for car plates, and subsidise electric vehicle purchases.
Outside of Asia, equity futures in the DMs point to further gains with contracts on the S&P 500 (+0.46%), NASDAQ 100 (+0.81%) and DAX (+0.46%) trading higher.
Oil prices are higher in Asia with Brent futures up +0.53% to $120.06/bbl, as I type. Over the weekend, EU diplomats failed to come to an agreement on the EU's proposed ban on Russian oil ahead of a 2-day summit with EU leaders starting today. Meanwhile, OPEC+ are set to meet on Thursday to discuss their production policy for July.
Turning to a recap of last week now. The S&P 500 finally managed to break its nearly two month long losing streak, gaining +6.58% (+2.47% Friday) over the week. Consumer discretionary stocks led the way, gaining +9.24% (+3.47% Friday), after being the worst performer YTD. The outperformance was twofold, one was better earnings news from discount retailers this week, the second was a continued reappraisal toward a softer Fed policy path, which saw cyclical stocks outperform in general. Nevertheless, all sectors were higher, bringing the S&P 500 to -12.76% YTD. US indices were green across the board, including the NASDAQ (+6.84%, +3.33% Friday), the Russell 2000 (+6.46%, +2.70% Friday), FANG+ (+7.83%, +3.15% Friday) and Dow Industrials (+6.24%, +1.76% Friday).
European stocks lagged slightly, as the drum beats on toward more ECB tightening, but nevertheless were also higher over the week, with the STOXX 600 gaining +2.98% (+1.42% Friday) while the DAX and CAC were +3.44% (+1.42% Friday) and +3.67% (+1.64% Friday), respectively.
On the rates side, Treasury yields retreated in light of the continued growth fears and potential for a shallower Fed path, with terminal fed funds rate pricing closing below 3%. Regular readers will know I don’t think the Fed is set to pause, or that terminal rates that low will ultimately rein in inflation at current levels. So we will see. Indeed, Core PCE in the US from April was released Friday, printing at 0.3% MoM, in line with expectations and showing no signs of deceleration. Nevertheless, 2yr Treasury yields fell -10.5bps (flat Friday), while 10yr yields were -4.3bps lower (-0.9bps Friday) in one of the least volatile weeks for Treasury trading this year. In Europe, 2yr bund yields increased +1.1bps (-0.3bps Friday) while 10yr yields gained +1.9bps (-3.5bps Friday), as the consensus behind a July liftoff and positive policy rates by year end grows among ECB officials.
Elsewhere, brent crude climbed +6.12% (+1.74% Friday), while the dollar came down from its lofty heights, with the broad dollar index retreating -1.45% (-0.17% Friday).
Rising price pressures, stronger and more persistent than generally expected, has been the main challenge for consumers, businesses, and policymakers. It…
Rising price pressures, stronger and more persistent than generally expected, has been the main challenge for consumers, businesses, and policymakers. It will stay top of mind in the week ahead as both the world's two largest economies, the US and China, report July consumer and producer prices.
During the Great Depression, the central governments discovered their balance sheets, and budget deficits became a nearly permanent fixture. This is true even for countries like Germany, which ostensibly shunned Keynesian demand management and embraced "ordo-liberalism." During the Global Financial Crisis, the central bank balance sheet was called into action as policy rates hit zero (and fell into negative territory for the members of the eurozone, Switzerland, a few other European countries, and Japan).
After the Great Financial Crisis, many monetarists and hard-money folks warned of ruinous inflation, which did not materialize. Instead, inflation has soared over the past year or so for most high-income and emerging market countries. The hard-money and monetarists say they told us so. Yet, it took a pandemic of biblical proportions to spur inflation and the Russian invasion of Ukraine. Moreover, there seems to be no correlation between the size of the central bank's balance sheet (as a percent of GDP), government deficit spending during and after the pandemic, and the subsequent inflation.
The Bank of Japan's balance sheet is nearly 135% of GDP. The Fed's balance sheet is about 36.5% of GDP. The ECB's balance sheet is almost 69% of GDP. Japan's central government debt is more than 2.3-times larger than its GDP. In proportionate terms, US debt is less than half as much as Japan's. The eurozone's debt-to-GDP is a little more than 95%. Consider fiscal policy. The cumulative budget deficit in the US for 2020 and 2021 was a stunning 26.4% of GDP. The deficit in the eurozone was less than half the size (12.2%). Japan's was almost 16% of GDP.
We will likely learn next week that the July US CPI (year-over-year) fell below the preliminary EMU reading of 8.9%. The median forecast in the Bloomberg survey sees a 0.2% month-over-month gain, which given the base effect, would be consistent with an 8.8% year-over-year rate. Energy prices have pulled back. Sept WTI fell 5.3% in June and and another 4.3% in July. It is off almost 10% so far this month. The average price of retail gasoline fell 13% in July.
Japan's headline CPI was a modest 2.4% in June. The BOJ's last meeting concluded the day before the June CPI was reported. Its updated forecast put this year's CPI at 2.4% before falling back to 1.3%-1.4% for the next two years. Do not be mistaken. The BOJ's forecasts are not an outlier. Economists surveyed by Bloomberg are also convinced Japan's inflation is temporary. The median forecast is a 1.2% rise in CPI next year, followed by a 0.8% increase in 2024.
Conventional wisdom is that monetary policy will not change until Governor Kuroda steps down next April. The inflation forecasts, if accurate, suggest the new governor will find that the deflation demon has not been slain after all. Although the BOJ's policy rate is -0.1%, it has been trading at -0.009%. The swaps market has it at 0.01% in a year, 0.07% in two years, and 0.11% in three years.
After arguably waiting too long to get going, the Federal Reserve has stepped up its game. It persuaded many, even if not everyone, that it is so determined to bring inflation down that it is willing to risk an economic contraction. This is important because it shows that inflation expectations are anchored. Consider the 10-year breakeven peaked in mid-April a little above 3.05% and fell to the year's low slightly below 2.27% a few weeks ago. It is now hovering in narrow band around 2.50%. In the middle of last month, the two-year breakeven fell to 2.85%, the lowest since October 2021. It popped back to around 3.25% but is approaching the low again. Recall it peaked shortly after the first rate hike was delivered in March 16, near 5%. Doesn't this say something about the Fed's anti-inflation credibility?
While the breakevens have been consolidating, we note the correlation between the changes in the 10-year yield breakeven and oil prices increased to almost 0.60 over the past 30 days, the highest in more than three months. The correlation between the changes in oil and the US two-year breakeven is around 0.83, the highest since the end of 2020. Surely, most observers would agree that whatever attenuated relationship there may be between fiscal and monetary policy on one hand and oil prices on the other, it is overshadowed by several other factors.
Last week, the Bank of England warned that inflation was likely to peak near 13%. That is twice as much as it anticipated at the end of last year when it began its tightening cycle. The main culprit is not monetary or fiscal variables but the supply shock from the energy sector. The BOE is also the first major central bank to acknowledge a recession. Indeed, it warns that the economy will contract for five consecutive quarters, which does not include the second quarter. The UK reports Q2 GDP on August 12, and the median forecast (Bloomberg survey) is for a small contraction.
Nevertheless, the BOE is clearly determined to continue to tighten monetary policy. Governor Bailey is cagey about the pace of hikes going forward, like many other central banks, including the Fed, ECB, and the Reserve Bank of Australia. Yet, the market remains fairly convinced that the central BOE will hike rates by at least another 100 bp in the last three meetings of the year. The BOE is also the first major central bank to announce intentions of actively selling some of its sovereign and corporate bond holdings to shrink its balance sheet quicker than the passive approach of allowing maturing issues to roll off.
The cottage industry of critics put the Federal Reserve in a "damned if they do and don't if they don't" box. First, many wanted the central bank to be more aggressive than even the hawks at the Fed advocated. Then as the economy slows, they are among the first to condemn the Fed for inducing a recession. Endless fodder for the large pipes that deliver the streaming news.
We have staked out a middle ground between those pundits and cynics who have been saying the US is in a recession for a few months and several Fed officials who suggest there is little sign of a broad economic slowdown. Yet, even Powell acknowledges the path to a soft landing is getting narrower. While recognizing we live in a probabilistic world, we see the odds of a soft-landing as minuscule at best.
It is not just because of monetary policy, which is tightening aggressively. Indeed, after the stronger than expected employment report, which saw a new cyclical low in the unemployment rate (3.5%) and the strongest jobs growth in five months (528k), the Fed funds futures were discounting around a 75% chance of another 75 bp hike at next month's meeting that concludes on September 21. The 2-10-year yield curve is inverted by the most since 2000 (almost 40 bp). Fiscal policy is tightening too, and aggressively at that. The OECD projects government spending to fall by 0.1% this year. The median forecast in Bloomberg's survey is for the budget deficit to fall to 4.4% of GDP this year from 10.8% last year. The two-month 25% slide in oil prices is helpful for the soft-landing scenario, but they have still doubled since early 2021, which proceeded the end of the last few business cycles.
Also, the inventory cycle has matured, and from a tailwind last year, it has turned into a headwind. If it weren't for the inventory adjustment, the US economy would have expanded in H1. The good news here is that the drag from inventories may be winding down. Another drag that may replace it is that some sectors that saw strong demand during the pandemic may have built too and cut back. Given that it was slow to take its foot off the accelerator, the Fed's biggest mistake would be to declare victory too early. This risk-reward assessment also injects a human element into the risks of a hard-landing.
The July CPI should offer some comfort that inflation, which jumped in Q2, is steadying at the start of Q3. After rising by 1.0% in May and 1.3% in June, the July CPI is expected to edge up by 0.2%. If so, it would match the smallest monthly increase since November 2020. It would also be consistent with a small decline in the year-over-year rate, which has only happened one other time since last August (in April). However, the core rate may tick up. The median forecast (Bloomberg survey) sees a 0.6% increase, which is the average over the last nine months. This would produce the first increase in the year-over-year core CPI since March. It peaked then at 6.5% and fell to 5.9% in June.
The market still expects the Fed to raise rates aggressively and double the pace of the roll-off from its balance sheet starting next month. The market is now looking for the Fed to hike rates by 125 bp in the last three meetings of the year. Look at what has happened. The year-end Fed funds rate has mostly been between 3.25% and 3.50% for the past two months. It pushed through the upper end after the jobs report.
Moreover, the Fed's hawkish rhetoric and the jobs report did not manage to dissuade the market from pricing in a cut in the Fed funds rate next year. Even if the terminal rate is a bit higher than the market previously thought, it seems more confident of a rate cut in H2 23. Specifically, the implied yield of the December 2023 Fed funds futures is about 33 bp below the yield of the December 2022 contract. Over the course of the week the chances of a cut in Q3 23 were downgraded. At the end of July, the September Fed funds yielded 32 bp less than the December 2022 contract. It closed last week at a 12 bp discount.
The team of economists at ITC found that since 1990, the first Fed cut has come on average 10.6 months after the last hike. It is in a range of five months to 18 months. If the market is right and the Fed finishes its tightening this year, or even early next year, it appears to be pricing in a fairly typical gap.
Much to the chagrin of some of the Fed's critics that put the hawks at the Bundesbank to shame, the market is confident that the economy will reach a point later this year or early next year that will prompt the Fed to ease off its drive. This is the real meaning of the central bank put. They will not pursue the old Mellon recommendation: liquidate, liquidate, and liquidate. The hawks do not have a constituency for it. And that seems global, not just limited to the US. But, of course, like playing three-card Monty, it always looks easy from the sidelines.
China's inflation will be reported after it its reserves (lower), trade surplus (smaller), and lending figures (less). The June CPI was at 2.5% year-over-year, roughly the midpoint seen since the onset of Covid (-0.5%-5.4%). It is expected to have edged up to 2.8% in July. The recovery in pork prices led to the acceleration in food inflation (2.9% vs. 2.3%). The core measure, which excludes food and energy, rose 1.0% year-over-year in June from 0.9% in April and May. Meanwhile, China's PPI is expected to lurch down, possibly below 5%, to its lowest level since March 2021. It peaked at 13.5% last October, and the decline in July will be the ninth consecutive monthly decline.
The subdued price pressures may give the PBOC room to ease policy, but it seems to be in no rush. It is encouraging lending and has offered some fiscal support. It has been mild. There appears to be a window to ease policy in the next couple of weeks. Liquidity conditions have tightened due to several factors, including PBOC draining operations and tax payments, and on August 16, a CNY600 bln medium-term lending facility matured. There are several ways that the PBOC could provide more liquidity, including a new medium-term lending facility, reverse repos, and a cut in reserve requirements.
Disclaimerrecession depression unemployment pandemic yield curve monetary policy rate cut fed federal reserve government debt budget deficit governor recession gdp recovery unemployment oil japan european uk germany ukraine china
Inflation Breakeven and Term Spreads Adjusted for Premia
Expected inflation inferred from the Treasury-TIPS spread is tainted by risk and liquidity premia. The difference between expected future short rates and…
Expected inflation inferred from the Treasury-TIPS spread is tainted by risk and liquidity premia. The difference between expected future short rates and current short rates is also obscured by risk premia. Here are adjusted spreads:
Figure 1: Five year inflation breakeven calculated as five year Treasury yield minus five year TIPS yield (blue, left scale), five year breakeven adjusted by inflation risk premium and liquidity premium per DKW (red, left scale), both in %. NBER defined recession dates shaded gray. Source: FRB via FRED, Treasury, NBER, KWW following D’amico, Kim and Wei (DKW) accessed 8/4, and author’s calculations.
The adjusted series suggests an upward movement in expected inflation with the expanded Russian invasion of Ukraine, but less than that indicated by the simple Treasury-TIPS spread (and no downward movement recently).
How have recent releases affected inflation expectations? Figure 2 presents a detail.
Figure 2: Five year inflation breakeven calculated as five year Treasury yield minus five year TIPS yield (blue, left scale), five year breakeven adjusted by inflation risk premium and liquidity premium per DKW (red, left scale), both in %. Source: FRB via FRED, Treasury, KWW following D’amico, Kim and Wei (DKW) accessed 8/4, and author’s calculations.
The inflation breakeven rises with the GDP advance and PCE deflator releases, but stays constant with today’s employment numbers (strangely). However, to the extent that the Treasury-TIPS spread mismeasures expectations, we should be a bit wary of this result (inflation expectations do drop with the GDP release with the adjusted measure).
What about the 10yr-3mo spread? The unadjusted has taken a big dive in recent weeks, coming close to inversion.
Figure 3: 10 year-3 month Treasury spread (dark blue), and implied future nominal rates over next ten years (pink), both in %. NBER defined recession dates shaded gray. Source: FRB via FRED, Treasury, NBER, KWW following D’amico, Kim and Wei (DKW) accessed 8/4, and author’s calculations.
The gap between 10yr-3mo went negative in 2019, and again with the onset of the pandemic. The yield curve steepened sharply with the Georgia special election outcomes, and then counterintuitively rose again with the Russian expanded incursion into Ukraine. The spread dropped sharply from May 6th onward.
The spread incorporates a inflation risk premium so that on average, the yield curve slopes up. Hence, the standard 10yr-3mo spread does not necessarily equal the difference between 3 month yields over the next 10 years vs the current 3 month yield. I show the sum of the future 3 month real yields and future 3 month inflation rates over the next ten years as the pink line in Figure 2. This line probably better shows the heightened expectations of growth in 2021Q1-Q2, as well as the dropoff in perceived growth prospects in May.
The detail suggests the expected asset price responses to the recent releases as well.
Figure 4: 10 year-3 month Treasury spread (dark blue), and implied future nominal rates over next ten years (pink), both in %. Source: FRB via FRED, Treasury, KWW following D’amico, Kim and Wei (DKW) accessed 8/4, and author’s calculations.recession pandemic yield curve spread recession gdp ukraine
Sixth recession red flag raised, despite strong jobs report
On the same day, the BLS revealed that we’ve recovered all the jobs lost to COVID-19 and I am raising my sixth recession red flag.
The post Sixth recession…
What a crazy day for my economic model! On the same day, the Bureau of Labor Statistics (BLS) revealed that we’ve recovered all the jobs lost to COVID-19 and I am raising my sixth recession red flag.
When I wrote the America is back recovery model on April 7, 2020, and then retired it on Dec. 9, 2020, I knew one data line would lag the most: jobs! I have talked about how job openings would move toward 10 million and that we should get all the jobs we lost to COVID-19 back by September 2022. Well, I was off by two months: Today, the BLS reported that 528,000 jobs were created with positive revisions of 28,000, which gave us just enough to pass the February 2020 levels.
From BLS: Total nonfarm payroll employment rose by 528,000 in July, and the unemployment rate edged down to 3.5 percent, the U.S. Bureau of Labor Statistics reported today. Job growth was widespread, led by gains in leisure and hospitality, professional and business services, and health care. Both total nonfarm employment and the unemployment rate have returned to their February 2020 pre-pandemic levels.
Feb 2020: 152,504,000
July 2022: 152,536,000
The big job numbers we have seen recently are tied to the decline in the job openings data, which lags also, but we do see a decrease in this data line as it appears for now that the job openings data has peaked in this cycle. It recently went from 11.3 million to 10.7 million, and the recent peak was near 11.9 million.
We have seen increases in jobless claims and slighter increases in continuing claims. However, nothing too drastic yet. Again, at this stage of the economic cycle you should focus on the rate of change data.
A tighter labor market is a good thing; this means people with less educational backgrounds can get employed since we have many jobs that don’t require a college education. The unemployment rate did tick up for those with less than a high school diploma in this report.
Here is a breakdown of the unemployment rate and educational attainment for those 25 years and older:
—Less than a high school diploma: 5.9%.
—High school graduate and no college: 3.6%
—Some college or associate degree: 2.8%
—Bachelor’s degree and higher: 2.0%
Below is a breakdown of the jobs created. Every sector created jobs; even the government created jobs. All this was just working our way back from the losses to COVID-19, which I knew would take a bit longer than some people would have thought with the economic data we had in 2021.
Now that we have regained all the jobs lost to COVID-19, what is next?
Hopefully, people know that we weren’t in a recession in the first six months of the year. When you’re in a recession, you don’t create jobs, have positive industrial production data, or positive consumer data in GDP. We had some funky trade and inventory data that tilted the GDP negatively, but the traditional data lines that go negative in a recession are just not there yet.
Even so, because some of the more current data is trending negatively, I am raising my sixth recession red flag today. Allow me to present my case.
Recession red flag watch
Where are we in the economic cycle? I’ve already raised five of my six recession red flags, but until they are all up, I don’t use the word recession.
Let’s review those red flags in order, as my model is based on an economic progression model:
1. The unemployment rate falls down to a level where we start to talk about Federal Reserve rate hikes because the economy doesn’t need as much stimulus for employment gains. For this recovery, the unemployment rate getting to 4% is the level where I raised my first recession red flag. This just means that the recovery is more mature than the earlier stages of the unemployment rate falling. Today it’s currently at 3.5%.
2. The Federal Reserve starts to raise rates. The Federal Reserve started Its rate hike process this year, to start fighting inflation and has been more aggressive recently. This shows that the expansion is longer and that the Federal Reserve is in a mood to tighten policy rather than make it more accommodative.
3. The inverted yield curve. This is more of a market-driven bond yield red flag. I had been on an inverted yield curve watch since Thanksgiving of 2021. This is when the two-year yield and 10-year yield slap high fives and say hi to each other. It’s another progression red flag, reflecting that we are in a more mature stage of the economy. Traditionally you see an inverted yield curve before every recession.
4. Find the overheating economic sector where demand can’t be sustained. Once that demand comes back to normal, people will be laid off. We see this in the durable goods data. A few companies are laying people off or putting into place a hiring freeze.
5. New home sales, housing starts, and permits fall into a recession. Once mortgage rates rise, the new home sales sector does get hit harder than the existing home sales market. The homebuilder confidence index is falling noticeably, and while we never had the housing build-up in credit and sales that we saw in 2005, the builders will slow housing production down with higher rates. I raised my fifth recession red flag in June.
Today, I am raising the last recession red flag, which considers the Leading Economic Index (LEI). This week I presented my six recession red flag model to the Committee For Economic Development of The Conference Board (CED) — the committee that created the leading economic index. “Since its inception in 1942, CED has addressed national priorities to promote sustained economic growth and development to benefit all Americans. CED’s work in those first few years led to great policy accomplishments. One is the Marshall Plan, the economic development program that helped rebuild Europe and maintain peace, the Bretton Woods Agreement that established the new global financial system, and the World Bank and International Monetary Fund.”
6. Leading economic index declines four to six months before a recession. Historically, the LEI fades into every recession, outside a one-time huge economic shock like COVID-19. To raise this flag I needed four to six months of decline, which we saw recently. However, knowing the components of this data line, I know this data line has legs to keep going lower.
As you can see, the LEI doesn’t have a good history of reversing course when the downtrend is in place. We have had times in the mid-1990s when we saw a slowdown but didn’t get a recession.
With that in mind, how might this reverse? Well, the two easy answers are this:
1. Rates fall to get the housing sector back in line.
2. Growth rate of inflation falls, the Fed stops hiking rates and reverses course, as they did in 2018.
Most Americans are working, and job openings are still high enough that people can find work if they need to. However, if you’re asking me how we could see a reversal after all six flags are up, this is it.
So how do I square raising the last recession red flag when we had such a strong job report today? Well, the model isn’t designed to work during a recession. It’s intended to show the progression of an expansion into a recession. As you can see below, this data line fell in 2006, and we were still creating jobs in 2006 and 2007.
During the housing bubble, we had a clear over-investment, and that was in the housing market, so the recession red flag model was evident before the recession. Only three of my recession red flags were up before the COVID-19 crisis; in fact, we were still in expansionary mode if COVID-19 hadn’t occurred.
I can’t describe it any other way: things have been crazy since April 2020. All of us that track economic data have had to adjust to the highest velocity of data movement in our lifetime and have had to make COVID-19 adjustments all the time.
At some point in the future, things will get back to normal. I’ve presented you with my data lines to show we weren’t in a recession the first six months of the year, but the economic data is getting softer and softer. I will be looking for weaker data lines getting to the point where we actually see real recessionary data, which means jobs are being lost monthly, production data falls and companies make adjustments to their business model with greater force.
I’ll take each data point one day at a time and try to make sense of it. Remember, economics done right should be very boring, and always, be the detective, not the troll.
The post Sixth recession red flag raised, despite strong jobs report appeared first on HousingWire.recession economic shock unemployment pandemic covid-19 stimulus economic growth yield curve fed federal reserve home sales mortgage rates housing market recession gdp recovery unemployment stimulus europe
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