Morning Commentary: Yield Curve Inversion – A Potential Ominous Sign

Foreign Exchange - Morning Commentary
Yield Curve Inversion – A Potential Ominous Sign
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Alan Rose
Alan Rose
Foreign Exchange Senior Trader
After yesterday’s optimism surrounding Brexit and the U.S.-China trade negotiations spurred a stronger British pound, Chinese yuan and many other commodity linked currencies, markets are generally sidelined and consolidating today. The big event on the calendar today is the Fed minutes from January. The Fed pivoted, reversed course and shifted to a more dovish bias and the word “patience” became the new flavor of the day for the Fed. How the markets interpret the Fed minutes from January today will be very important for the U.S. interest rate markets and all other asset classes.
Yield curve inversion is a very important metric for the market and occurs when U.S. short term interest rates move above longer term U.S. yields. The standard barometer for measuring this phenomenon is when U.S. 2-year yields cross above U.S. 10-year yields. The spread currently is around 15 bps but got down to 9 bps in December at the height of the global equity meltdown when investors became concerned about a global economic slowdown. The spread had been near 40 bps in October before the global stock market meltdown commenced.
Why is this metric so important? Because yield curve inversion is a classic signal that a recession is coming. The yield curve has inverted before each recession in the past 50 years; it has had one false signal in that 50-year time span. The economy has taken anywhere from 12 to 24 months to fall into a recession when the yield curve inverts. While U.S. and global equities have rallied strongly during January and February, U.S. and G7 interest rates remain suppressed as concerns remain about a global slowdown. Today’s Fed minutes will be very important and will be released at 11:00 PST.
  • Evidence of a slowdown in global trade continues to be seen in almost all the major economies. Japan released its trade data for January and it was disappointing as exports declined much more than expected YoY by 8.4%, creating a much larger trade deficit. Japanese exports to China fell by 17% YoY which is evidence of a continued slowing of demand in the Chinese economy. The Japanese yen is slightly weaker today and has weakened nearly 2% since January 4.
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