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“Worst Start Since 1788”: A Closer Look At The Catastrophic First Half Performance

"Worst Start Since 1788": A Closer Look At The Catastrophic First Half Performance

As discussed yesterday…

Worst first half for stocks…

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"Worst Start Since 1788": A Closer Look At The Catastrophic First Half Performance

As discussed yesterday...

... and again this morning, when Rabobank's Michael Every said that "if you bought stocks in H1, you lost; if bonds, you lost; if commodities, you were doing great until recently; if crypto you lost; if the US dollar, you were fine" but lost purchasing power to inflation, the first six months of the year were terrible.

Just how terrible? To quantify the destruction, we go to the latest chart of the day from DB's Jim Reid who writes that "the good news is that H1 is now over. The bad news is that the outlook for H2 is not looking good."

To demonstrate just how bad H1 was, Reid shares three charts.  They show that:

1) Deutsche Bank's US 10yr Treasury proxy index did indeed see the worst H1 since 1788 in spite of a sizeable late June rally, and...

2) the S&P 500 saw the worst H1 total return since 1962 after a rally last week just pulled it back from being the worst since 1932.

Here, BofA has outdone DB, and notes that in real timers, the S&P500's performance was the worst since 1872!

As Reid further notes, "I’ve found through my career that these type of charts are always the most demanded as investors want to put their performance in context." Which is why he also added a the third chart which is an abridged version of one published by DB's Henry Allen in a report fully reviewing H1, June and Q2 (more below, and also available to professional subs in the usual place).

As Reid concludes, "if you like horror stories its an alternative to Stranger Things which returns to our global screens today. Obviously if you run a commodity fund you may think differently!"

Stepping back from this narrow take, we look at the full performance review for June and Q2 conducted by Reid's colleague, Henry Allen, which finds that "it's hard to overstate just how bad markets have performed over recent months, with the returns in Q2 very much following in Q1’s footsteps... a range of asset classes saw significant losses, including equities, credit and sovereign bonds, whilst the US dollar and some commodities like oil were among the few exceptions. In fact, in total return terms we’ve just seen the biggest H1 decline for the S&P 500 in 60 years, and in June alone just 2 of the 38 non-currency assets in our sample were in positive territory, which is the same as what we saw during the initial market chaos from the pandemic in March 2020."

On a YTD basis as well, just 4 of 38 tracked assets are in positive territory, which as it stands is even lower than the 7 assets that managed to score a positive return in 2008.

The main reason for these broad-based declines is the fact that recession and stagflation risks have ramped up significantly over Q2. This has been for several reasons, but first among them is the fact that inflation has proven far more persistent than the consensus expected once again, requiring a more aggressive pace of rate hikes from central banks than investors were expecting at the start of the quarter. For instance, the rate priced in by Fed funds futures for the December 2022 meeting has risen from 2.40% at the end of Q1 to 3.38% at the end of Q2. A similar pattern has been seen from other central banks, and the effects are beginning to show up in the real economy too, with US mortgage rates reaching a post-2008 high. The good news is that as of today, the market is now pricing in not just rate hikes to peak in Q4, but about 14bps of rate cuts in Q1.

in any case, the big worry from investors’ point of view is that the cumulative effect of these rate hikes will be enough to knock the economy into recession, and on that front we’ve seen multiple signs pointing to slower growth recently in both the US and Europe. For instance, the flash Euro Area composite PMI for June came in at a 16-month low of 51.9, whilst its US counterpart fell to a 5-month low of 51.2. Other recessionary indicators like the yield curve are also showing concerning signs, with the 2s10s Treasury curve still hovering just outside inversion territory at the end of the quarter, at just +5.1bps. The energy shock is adding to these growth concerns, and that’s persisted over Q2 as the war in Ukraine has continued. Brent crude oil prices built on their sizeable gains from Q1, with a further +6.4% rise in Q2 that left them at $115/bbl. Meanwhile, European natural gas is up by +14.8% to €145 per megawatt-hour. However, fears of a global recession have knocked industrial metals prices significantly, and the London Metal Exchange Index has just seen its first quarterly fall since the initial wave of the pandemic in Q1 2020, and its -25.0% decline is the largest since the turmoil of the GFC in Q4 2008.

That decline in risk appetite has knocked a range of other assets too:

  • The S&P 500 slumped -16.1% over Q2, meaning its quarterly performance was the second worst since the GFC turmoil of Q4 2008.
  • Sovereign bonds built on their losses from Q1,
  • Euro sovereigns (-7.4%) saw their worst quarterly performance of the 21st century so far as the ECB announced their plan to start hiking rates from July to deal with high inflation.
  • Cryptocurrencies shared in the losses too, with Bitcoin’s (59.0%) decline over Q2 marking its worst quarterly performance in over a decade

Which assets saw the biggest gains in Q2?

  • Energy Commodities: The continued war in Ukraine put further upward pressure on energy prices, with Brent crude (+6.4%) and WTI (+5.5%) oil both advancing over the quarter. The rise was particularly noticeable for European natural gas, with futures up by +14.8% as the continent faces up to the risk of a potential gas cut-off from Russia.
  • US Dollar: The dollar was the best-performing of the G10 currencies in Q2 as it dawned on investors that the Fed would hike more aggressively than they expected, and the YTD gains for the dollar index now stand at +9.4%.

Which assets saw the biggest losses in Q2?

  • Equities: Growing fears about a recession led to significant equity losses in Q2, with the S&P 500 (-16.1%) seeing its second-worst quarterly performance since the GFC turmoil of Q4 2008. That pattern was seen across the world, with Europe’s STOXX 600 down -9.1%, Japan’s Nikkei down -5.0%, and the MSCI EM index down -11.4%.
  • Credit: For a second consecutive quarter, every credit index we follow across USD, EUR and GBP moved lower. EUR and USD HY saw some of the worst losses, with declines of -10.7% and -9.9% respectively.
  • Sovereign Bonds: As with credit, sovereign bonds lost ground on both sides of the Atlantic, and the decline in European sovereigns (-7.4%) was the worst so far in the 21st century. Treasuries also lost further ground, and their -4.1% decline over Q2 brings their YTD losses to -9.4%.
  • Non-energy commodities: Whilst energy saw further gains over Q2, other commodities saw some major declines. Industrial metals were a significant underperformer, with the London Metal Exchange Index (-25.0%) seeing its largest quarterly decline since the GFC turmoil of 2008. Precious metals lost ground too, with declines for both gold (-6.7%) and silver (-18.2%). And a number of agricultural commodities also fell back, including wheat (-13.6%).
  • Japanese Yen: The Japanese Yen weakened against the US Dollar by -10.3% over Q2, which also marked its 6th consecutive quarterly decline against the dollar. By the close at the end of the quarter, that left the Yen trading at 136 per dollar, which is around its weakest level since 1998. That came as the Bank of Japan has become the outlier among the major advanced economy central banks in not hiking rates with even the Swiss National Bank hiking in June for the first time in 15 years.
  • Cryptocurrencies: The broader risk-off tone has been bad news for cryptocurrencies, and Bitcoin’s -59.0% decline over Q2 is its worst quarterly performance in over a decade. Other cryptocurrencies have lost significant ground as well, including Litecoin (-59.2%) and XRP (-61.2%).

June Review

Looking specifically at June rather than Q2 as a whole, the picture looks even worse in some ways since just 2 of the 38 non-currency assets are in positive territory for the month, which is the same number as in March 2020 when global markets reacted to the initial wave of the pandemic. The two positive assets are the Shanghai Comp (+7.5%) and the Hang Seng (+3.0%), which have been supported by improving economic data as Covid restrictions have been eased. Otherwise however, it’s been negative across the board, and even commodities have struggled after their strong start to the year, with Brent crude (-6.5%) and WTI (7.8%) posting their first monthly declines so far this year as concerns about a recession have mounted. The main catalyst for this was the much stronger-than-expected US CPI print for June, which triggered another selloff as it dawned on investors that the Fed would be forced to hike rates even more aggressively to rein in inflation, which they followed through on at their meeting when they hiked by 75bps for the first time since 1994.

Finally, without further ado, here are the charts showing total returns for the month of June...

... for Q2...

... and for YTD.

Tyler Durden Fri, 07/01/2022 - 15:00

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Government

Inflation

Rising price pressures, stronger and more persistent than generally expected, has been the main challenge for consumers, businesses, and policymakers. It…

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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.  


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Spread & Containment

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…

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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.

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Economics

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…

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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.

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