Morning Commentary: Inversion – A Historical Warning Sign
A daily summary and commentary of events and factors that affect the global markets, with a particular emphasis on the foreign exchange markets.
Inversion – A Historical Warning Sign
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Alan Rose Foreign Exchange Head Trader
Yesterday, we had warned that the euphoria in the markets surrounding the détente over a trade war between the U.S. and China could be short lived; we did not anticipate just a one-day rally. As yesterday unfolded, markets became concerned about a lack of specifics regarding the trade deal and while stocks held onto their gains for the most part, the early morning euphoria faded, U.S. interest rates began to falter again and the DXY weakened.
There have been a number of key overriding issues that have been at the heart of the angst and anxiety causing a sharp correction in equities beginning in October spilling out into many other asset classes. Interest rates and the flattening of the yield curve have been reflecting this anxiety that has caused equities to correct as longer term interest rates flatten out while short term rates have remained better bid. This flattening of the yield curve and interest rate inversion (short term rates above long term rates in some parts of the yield curve) is a concern for the markets and has been a historical barometer for forecasting recessions.
Inversion puts U.S. exceptionalism at risk as the market prices in potentially weaker growth ahead and the U.S. interest rate advantage that has been propelling the DXY higher over the past few years begins to evaporate. U.S. 2-year yields against U.S. 10-year yields is the market metric and is at its narrowest differential since 2007 at 12 bps. 2-year yields are higher than 3 and 5 year yields today for the first time in 10 years.
These signals are warning signs of a potential U.S. economic slowdown ahead. The DXY is weaker across the board today against almost all the major and emerging market currencies because of this phenomenon. U.S. 10-year yields have cracked below the 3.00% level and are sitting at 2.95% which is the lowest level since September 13 and is below its key 200-day moving average. This flattening of the yield curve and interest rate inversion makes the Fed’s job just that much more difficult going forward. The U.S. jobs report is on Friday and will be a key short term determinant for the markets.
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
The Reserve Bank of Australia kept interest rates unchanged at 1.50%. The central bank was upbeat about growth and the labor market but remained concerned about global growth amidst rising trade tensions. The Aussie dollar is only marginally stronger on the session while many other key currencies are outperforming.
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