The US yield curve fell to its flattest level since the crisis on Tuesday as Fed chair Powell dismissed the potentially recessionary signal. All currencies are down against the USD. GBP is the biggest loser on weaker than expected UK inflation, but with the headline CPI at 2.4% 00 well over the BoE target, the case for an Aug 2nd rate hike remains. The Premium DAX short was stopped out.
Not always recessionary but.There is a raging debate inside the Fed about the implications of an inverted yield curve. Over the past half-century every inversion has triggered an interest rate cut by the Fed but not always a recession. On Tuesday, the difference between 10-year and 2-year yields fell to just 24 basis points. If the Fed hikes as anticipated, it will almost surely invert in the year ahead. Chapter 6 of Ashraf's book goes deeper in each of the yield curve inversions over the past 40 years. In it, Ashraf asserts that the inversion of 1998 did not lead to recession, but certainly predicted a series of Fed rate cuts in autumn of that year in light of the LTCM debacle. For traders, it is more important to be able predict rate cuts, or changes in the tightening cycle, than actual recessions.
So is it a signal? Powell doesn't think so. On Tuesday he weighed in to say that the only real signal from the yield curve is in regards to neutral rates. Time will tell if that's true or not but in the short term, the takeaway is that an inverted yield curve, or the threat of it, won't pevent Powell from continuing to hike rates.
Like in quantum physics, since the market now knows Powell won't stop hiking because of an inverted curve, it makes a recession more likely. That's because 1) it's a sign Powell will be more aggressive 2) Yields won't be restrained (as much) by the implied or real threat of the Fed slowing down because of inversion.
In the short run, Powell's comments helpe boost the US dollar, but in the longer-term, his stance may prove to be a risk to the US and global economy.
InsuranceThe crux of the problem continues to be that developed-market inflation remains restrained due to globalization and automation. The Fed is hiking because it believes a tighter jobs market will inevitably lead to inflation but that may no longer be true. More importantly, the Fed intends to normalize interest rates as far as it want in order to secure sufficient firepower in the event of the next recession. i.e. Fed funds rates will be high enough to be reduced.
|2.4%||2.6%||2.4%||Jul 18 8:30|
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Some key metrics on US retail sales were soft Monday but revisions helped to bolster the dollar. The Swiss franc was the top performer while the Australian dollar lagged. New Zealand CPI is up next. A new Premium trade in CHF has been issued ahead of tomorrow's Congressional testimony by Fed chair Powell. The Premium video on today's new trade and existing trades is found below.
US retail sales matched the +0.5% consensus expectation in June but with May's revision to +1.3% from +0.8%, the overall tone of the report was stronger. The effect was less-pronounced once volatile categories like autos, gas and building materials were stripped out but the report was still enough to halt a decline in the US dollar on the day. Can the true health of the US consumer be assessed via volatile items? And will Powell sound relaxed about the recent gains in inflation in tomorrow's testimony?
Cable climbed as high as 1.3295 before backing off to 1.3230. Part of GBP weakness was due to uncertainty about May's government but she eventually won a Brexit amendment vote 303 to 300. She remains in an extremely precarious, almost impossible position and it would be remarkable if she managed to hang onto her job until the 2022 election.
It's also not entirely clear what would be the reaction if she were forced out or quit. Initially there would be turmoil and GBP selling but others might see it as a path to a soft Brexit or another referendum, which could be positive. Ultimately, it's tough to see any future where both Brexit sides call a truce and move on.
The big move in financial markets in the past week has been oil and that extended with a 4% decline on Monday. Key levels from the recent run-up have been broken and the 61.8% retracement of the June-July rally is now hanging by a thread.
Interestingly, USD/CAD finished lower despite the drop in oil price. If crude continues to fall, that surely won't last.
Looking ahead, New Zealand CPI is due up at 2245 GMT and expected up a modest 1.6% y/y. Later, sterling will be back in focus with jobs data at 0830 GMT.
|0.5%||0.5%||Jul 16 22:45|
|Fed Chair Powell Testifies|
|Jul 17 14:00|