Morning Commentary: The R Word

Foreign Exchange - Morning Commentary
The R Word
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
The word recession has been in heavy circulation in the financial markets since the inversion of the 2yr/10yr yield curve, for the first time since 2007, yesterday.  However, given the evolution of the financial markets, there are questions as to the reliability of this measure in predicting an impending recession.  US yields now represent the global economy more than the US economy.  Additionally, the term premium has also declined materially, making an inversion more likely despite no change to underlying fundamentals.  Moreover, on average over the past 5 recessions, the 2yr/10yr curve inverts for 247 days (208 consecutive days) prior to a recession.  So while the 2yr/10yr curve inverting has meaning, it isn’t to the point where it could be considered a strong recession signal on its own. 
 
The question now becomes, what are the other data points that warrant watching? Looking at data around past recessions, initial jobless claims, auto sales and aggregate hours worked are three of the top indicators.  This makes sense given that consumer consumption makes up 70% of the US economy.  When business slows down, hours worked is one of the first things to get cut back with job cuts to follow should things get worse.  Clearly, less income (less hours worked/job loss) impacts consumer purchases. 
 
Exacerbating concerns of an impending recession is the record setting length of the current expansion.  To this point, we note that expansions don’t die of old age but, rather, policy mistakes.  Unfortunately, chances for a policy mistake are higher than normal.  An intensifying trade war with China and hints of a currency battle have added to the already weak global growth picture.  Additionally, central banks around the world are working with limited ammunition.
 
Ultimately, you never want to overreact to any single data point, and overall, the US economy remains resilient—see the most recent jobs number.  Additionally, economic data around the world came in positive today.  However, there are certainly headwinds now that weren’t present in 2012 and 2015 when the US economy flirted with recession and ultimately returned to above trend growth. 
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
  • US yields are up from their lows on the back of strong US data.  Empire manufacturing, the Philly Fed business outlook survey, and retail sales all came in much stronger than expected.  US initial jobless claims missed expectations as it came in at 220k but still remains solidly below the key 300k level.
  • UK retail sales also beat expectations and has made the GBP the top performing G10 currency as it hit a 1-week high.    
  • Australian jobs data came in much stronger than expected with the country adding nearly 3 times more jobs than expected.  The AUD is the second best performer on the day on hopes the RBA could hold off on rate cuts.  The RBA has identified the labor market as a key measure it is watching.
  • US-China trade tensions whipped around this morning with China calling the US’s implementation of additional tariffs a violation of the agreement between Trump and Xi and signaled it would have to respond.  However, the markets were boosted by calls from China to “meet halfway.”  As a reminder, the US delayed the implementation of some, but not all, of the most recent round of tariffs. 
  • Hong Kong has announced fiscal stimulus last night as it hopes to support its lagging economy. 
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