Morning Commentary: Yield Curve REVERSION

Foreign Exchange - Morning Commentary
Yield Curve REVERSION
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Alan Rose
Alan Rose
Foreign Exchange Senior Trader
The removal of the potential use of tariffs against Mexico has provided a short term catalyst and some relief from the overly negative psychology that is permeating the global interest rate market. The “sky is falling” mentality is an apt description for the incredibly rapid decline of U.S. and global interest rates as markets fear a global slowdown or a recession down the road. A short term relief rally in U.S. and global stocks is also allowing for G7 interest rates to rise in the short term. Perhaps enough negative news has been priced in for the time being regarding future growth.
 
Yield curve inversion is a warning sign of an impending recession. When interest rate markets were in full panic mode on June 3, the U.S. 3-month against 10-year bond yield was inverted by 26 bps; it is now only inverted by 11 bps. The classic signal of 2-year yields against 10-year yields has not inverted yet and sits at positive 22 bps.  U.S. 2- year yields have also regained some footing after touching 1.77% last week and are now sitting at 1.93%. These two factors have allowed the U.S. dollar to stabilize after falling sharply over the past two weeks, but the situation remains very fluid.
 
All of the markets will remain highly focused on economic data and the U.S.-China trade negotiations. The next Fed meeting is on June 19. Many economists believe the June meeting is too early for the Fed to lower interest rates, but they will most certainly lay the groundwork for such a move. The July 31 meeting of the Fed is where most expectations and probability remain for a cut in interest rates. Even that probability has reduced from Friday’s 83% probability to 76% this morning. Continue to expect volatile markets; we remain slightly biased towards a weaker U.S. dollar in the near term.
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
  • U.S. PPI for May generally met expectations rising by 0.1%. Ex-food and energy also met expectations, rising by 0.2%. PPI YoY came in at its slowest pace in one year dropping below market consensus to 1.8% after coming in at 2.2% last year. U.S. CPI comes out tomorrow.
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