Something Wicked This Way Comes
The undead are rising, and they are not happy.
We are entering the time of the undead. Several stories converge this morning to say we are sliding into a recession, including one by Wolf Richter that doesn’t scream out “recession,” yet presents one of the strongest recession signs of all, which is, counterintuitively, the day the yield curve un-inverts (or reverts) back to having shorter-term yields priced lower than long-term yields. The un-inversion is the sign of the undead rising from their graves. We are nearing that time, according to Richter. I’ll let him explain:
The unloved 20-year Treasury yield – “unloved” because it has been higher than the 30-year yield ever since the 20-year Treasury security was introduced in May 2020 – spiked 13 basis points today, after rising 8 basis points yesterday, to close at 5.13%, making it the first of the long-term yields to blow over the 5% line.
Over the past two weeks, the 20-year yield has spiked by 56 basis points. When bond yields rise, bond prices fall, and so this has been a bloodbath for existing bond holders. Future buyers are ogling the juicy 20-year yields and are licking their chops. But they don’t want to get caught up in the next bloodbath either. Because it has been one bloodbath after another, interrupted by sucker rallies.
The 20-year yield has now nearly caught up with the two-year yield, which rose to 5.15%, putting this portion of the yield curve within a hair – within just 2 basis points – of uninverting….
The spread between the two-year yield and the 10-year yield has now narrowed to 34 basis points, the narrowest since October 27, 2022. This portion of the yield curve had inverted in July 2022, when the Fed aggressively pushed up the short-term rates with 75-basis-point hikes, while the long-term bond market was in total denial amid widespread pivot-mongering.
I like his mention of the denial and especially “widespread pivot-mongering,” one of my biggest pet peeves of that period that exhibited how deep in denial the peevish market was. The market proved to be wrong — very, very, wrong, and it is learning that lesson the hard way now as the bear-market rally that was inflated with that kind of denial finally drains off its hot air.
Having said all of that, Richter still doesn’t see a recession coming anytime soon, so on that much we disagree:
The inversion of the yield curve back then was another item, one of many items, that put us here at WOLF STREET on intense recession watch, and we’re still on recession watch, and there’s still no recession, far from it, the economy seems to have accelerated in Q3.
There is, of course, more reverting back to normal for the yield curve to do along different points of the curve, but movement is happening quickly, and the Fed says its most reliable guide to recession is the yield curve and particularly the time it goes out of inversion (reverts toward normal) because this always happens before the impending recession that the curve was signaling hits.
Now, I said a couple of years back the yield curve inversion would be slow to happen because of the Fed’s total control over the curve as it was deciding where to buy and sell Treasuries, which control the Fed would increasingly lose as it rolled off Treasuries. So, I said yield curve would likely not invert until we were already in a recession. I said it would “be late to the party.” True to what I anticipated, the yield curve inverted in the early half of 2022, which was when we found out we were already in two quarters of what would always technically have been considered a recession.
I’ve said since then that we’d enter a second dip of that recession this year, and I still anticipate that, though the GDP numbers certainly do not agree with me, but GDI does. I shouldn’t be surprised if the yield curve — slow as it was to arrive at the party — will be equally slow to leave, not reverting until we are already in recession. It will go out as it came. There are plenty of signs, even in today’s news that the economy is not accelerating in the present quarter, regardless of whatever might be true about Q3, but is headed the other way.
Those tricky jobs, for example that got the market all lip-bitingly fear-filled the other day when they soared, just flipped on their head in today’s report. The market was jolted when jobs screamed that the economy was hot. Today’s ADP payroll report came in at a dismal 89K new jobs for September, which was far, far below expectations.
It seems the labor market is in a period of transition where it keeps flipping between one direction and the other, and that is hardly surprising, given what an anomalous market it has become since the Covid lockdowns and given how transitions in anything tend to be vacillate — take the major season change in seasonal weather where you might get a violent flip but often get a stormy period that moves in and out of fall weather — a few rainy days that are cool, a few summer days, then back to cool nights and some drizzling rain. (At least in the northwest, but even in Hawaii, where the weather is roughest during the transitional periods. So, let nature give us a lesson about seasonal transitions because we are swinging hard now toward a stormy October in markets.)
Markets are finally reading the Fed’s memo: higher for longer. That memo has been circulating for about a year, but folks have shuffled it around and buried it under stuff, and never got around to reading it. But the Fed governors, and Chair Powell himself, are now a constant ebb-and-flow of higher-for-longer.…
Inflation is turning out to be tricky and nasty, and it comes and goes, and moves between different categories of goods and services, and it dishes up head-fakes and drives people nuts.
Exactly. This is the period where inflation returns to rising that I was predicting for this year because, as Richter says, inflation is sticky and nasty. It does that. The Fed picked off the low-hanging fruit — the non-sticky kinds of inflation, but sticky inflation, such as the way wage increases drive up all other things, which then drive a new round of wage increases, and the way oil drives up all other things — those hang around longer. They develop into vicious circles that spiral upward like a fire tornado.
And there is still all this QE liquidity sloshing around, doing all kinds of weird stuff to prices and fueling demand and inflation and the economy, despite the higher rates, and so the recession that should have come in late 2022 or at least in 2023 called in and canceled, and it said it might set a new date for later. Everyone is trying to figure this out.
I don’t really think it is that hard to figure out. I think he’s got it right, except that recession did come in 2022, but the powers that be just refused to call two quarters of declining GDP a recession on the basis that the “labor market was strong.” They were wrong. The problem is that they totally misunderstood what labor market tightness meant. It didn’t mean a strong economy. It meant weak and practically dying labor. It meant the labor pool became the dead pool. It just didn’t show back up for work after the artificial lockdowns. So, reading tight labor as a sign that GDP was wrong about a recession in 2022 was dead-wrong in itself.
However, the recession that came in early 2022 — yield curve inversion being late to the party because the Fed had seized full control of yield with mammoth bond buying — when GDP did crash, did, as Richter says, “call in and cancel.” And it also did, as I promised would be the case back then, “set a new date for later.” It was, however, rather vague as to when that new date would be.
I would say, the reversion of the yield curve may be signaling its arrival now because yields are still catching their breath after all the huge distortion the Fed pumped into them for years, and the Fed’s massive QT may be distorting how the curve is able to respond at present, still not being under total market control, but partially determined by what parts of the yield curve the Fed rolls off in huge sums based on how it timed its initial purchases of various maturities of bonds that distorted the curve.
In other words, we are caught up in Fed loops. It’s a loopy financial world, long held unconscious and captive by powerful Fedmeds, and it is only slowly coming out from under the Fed’s control as interest rates reprice more to market and as the Fed loses its grasp on more and more treasuries (by intention). It is becoming more market-driven. Until it is fully market driven, the forward indicators cannot be expected to reflect things like recession in a timely manner because recession is a market condition, as reliably as they otherwise would.
“… Till something breaks.” But honey, the biggest thing has already broken: price stability. On Wall Street, the meme is that the Fed will hike “until something breaks,” but the biggest thing that the Fed is in charge of, price stability, has already broken into a million little pieces, and the Fed is now trying to glue it back together with rate hikes and by removing the QE liquidity from the markets.
Market pricing has been piecing back together as the Fed shatters the delusional “recovery” economy it created. It was always a fake recovery in that it ALWAYS depended fully on continued Fed life support, and since the final days of the Great Recession, I’ve said, when the life support is fully removed, the recovery will fully die. We’ve never seen it fully removed since those days, and we won’t even get to full removal before the death throes become beyond bearing because the recovery is so overinflated and ridiculous that it is not going to unwind in a controlled manner. The Fed, as Richter goes on to note, has a great deal of unwinding yet to do:
With its QT, it has already removed nearly $1 trillion in liquidity, but that’s just drop in bucket, so to speak.
And,yet, we already feel how horribly wobbly the whole top-heavy, under-supported, deeply flawed, Fed-rigged monstrosity of bubbles is becoming:
What is sending stocks and bonds skidding is QT and these higher yields, but particularly QT.
Again, we agree. Higher interest slows the creation of new money through bank loans, but QT is a vacuum cleaner that sucks existing money out of the economy. Thus as I noted earlier this week, we are seeing money supply fall at the steepest and deepest rate of decrease since the Great Depression. That’s “depression,” not “recession.”
However, we still disagree on this one bit:
The economy is plugging right along and looks to have accelerated in Q3
There are plenty of stories just in today’s news, besides that terrible jobs report, to say the economy is far from being all it is cracked up to be.
First, things will fall apart quickly now that the denial in stock and bond markets is cracking. As Richter says, we are seeing a bond “bloodbath” as bonds finally try to catch up in yields/interest to where they should have been. And as another story in the news reports below, “Bond yields could race through 5% in next couple of weeks, market forecaster Jim Bianco warns.”
That wealth-destruction effect is likely to seize up a lot of activity in many marketplaces in fairly short order now that the interest is screaming through the marketplace like a bone-chilling Halloween ghoul. We are already seeing it in how the housing market has frozen over solid as rising bond yields translated into equally fast-rising mortgage rates. We’ll see it in many things if the bloodbath continues, as I am sure it will.
How big is the bloodbath at the long end of the curve? For example, the iShares 20+ Year Treasury Bond ETF [TLT], which focuses on Treasury bonds with a remaining maturity of 20 years or more, fell another 2.2% today. Over the past six months, it has plunged 20%. And from its high at the peak of the 40-year bond bubble in August 2020, it has now plunged by 50%….
If the Fed hikes one more time, and if the yield curve gradually uninverts, long-term yields would be headed over 6%, and that would produce another bloodbath.
Moreover, the present bloodbath isn’t over. Get ready for a ghoulish October that changes a lot of things … like that bad weather setting in.
As another writer says in the stories below today,
Something is breaking in financial markets
Getting used to a more typical rate structure doesn’t sound like such a terrible thing. But after 15 years of living in an unnaturally low rate regime, normal sounds, well, abnormal….
“All of this has to be assimilated and digested by the market,” said Quincy Krosby of LPL Financial. “You can see that it’s troubling and it’s difficult.”
Wait and see. You ain’t seen nothin’ yet.
That cracking sound in financial markets isn’t the typical kind of break, where one asset class or another fractures and gives way. Instead, this is more a break in a narrative, one that has widespread repercussions.
That’s right. It’s a regime change, which makes it unlike anything seen in decades. The crash into the Great Recession was merely a set of minor interest hikes set to cool a bubbly housing market. There was only one precarious bubble to break, but this has become an entire bubble economy with stocks, bonds, housing and other things priced to the sky and now coming down because of Fed interference in the market place.
The narrative in question is the one where the Federal Reserve holds interest rates low and everyone on Wall Street gets to enjoy the fruits.
Yes, it is. And we should not be surprised if, after so many years of intense price manipulation, some of our metrics and gauges are a little sticky, too.
And here we hear the story again:
In its place comes a story in which rates are going to stay higher for longer, an idea Fed officials have tried to get the market to accept and which investors are only now beginning to absorb.
The pain of recognition was acute for Wall Street on Tuesday, with major averages down sharply across the board and Treasury yields surging to their highest levels in some 16 years….
The surge in rates is especially ominous as corporate America heads to third-quarter earnings reporting season, which is right around the corner.
“All of this has to be assimilated and digested by the market,” Krosby added. “You can see that it’s troubling and it’s difficult.”
Expect major indigestion from this batch of poisoned Halloween candy.
The carnage really got going following the 10 a.m. ET release of a Labor Department report showing that job openings took a sudden swing higher in August, countering the prevailing wisdom that the employment picture was loosening and thus putting less upward pressure on wages.
And that’s why the stock market became unhinged again today and went back up … because the crashing job market gave oxygen to the smoldering narrative again that the Fed is getting inflation under control, but it is not! Not enough anyway, and the market will soon have to face that again. Moreover, jobs falling as low as they did today are recessionary, so the market will have to face recession as the cure for inflation, and even that may not work as it is a stagflationary recession, as I’ve always said.
Even if it does work, the market always crashes in recessions, so this not a path that is going to save the stock market. It is just that the stock market hates normalization and the loss of those easy candied fruits that the Fed fed to it to make it rich; so, much like a crying baby, the market would rather see signs of recession than see its bond-bond yields rising.
In turn, traders grew worried that the central bank would be forced to keep monetary policy tight. That sentiment was buttressed this week, when at least four policymakers either endorsed hikes or indicated that higher rates would be staying in place for an extended period.
The market returned to its delusions today, but there is very little left to feed its hopes that the Fed is done strangling it and feed the economy, other than new signs like this job report that the economy is now suffocating, so maybe the strangling can end soon. But the hope that impending death, at least, bring relief from the strangling is the hope of a zombie brain.
We’re going to find the fake Fed economy of yesteryear falls apart quickly because it was built of tissue made from old dollar bills. The article just quoted goes on to lay out some of the risks that lie ahead in this dying process if you want to read them, but I’ll move to another story from my aggregated headlines below to let Bill Bonner summarize the current state of affairs eloquently … as something wicked this way comes:
Fighting the Fed: A worldwide bond slide, stocks roll over and... hey, what's that cracking sound?
There was no joy on Wall Street yesterday. Little by little, day by day, it is becoming clearer: getting home won’t be easy….
Remember, this is a transition period. It’s hard to get a sense of what is really going on. But nearly three years ago, it looked to us as if the Primary Trend had reversed. We thought we were at the beginning of a major bear market. Stocks and bonds were headed lower….
‘Higher for longer’ is causing cracks in many different mirrors. Home buyers, for example, are looking at 30-year fixed-rate mortgages that are butting up against 8%….
Our baseline assumption is that higher interest rates will trigger a financial crisis. But they’ll cause an economic crisis too. Many homeowners with low-rate mortgages can’t afford to sell their houses. They’ve got a sweet deal; they need to hold onto it. Other people – looking at much higher interest payments – can’t afford to buy….
But the cracks and crumbling aren't limited to the housing sector. The basic building brick for the whole world’s financial edifice is the US 10-year T-bond. Yesterday, the real yield (adjusted for inflation) on the 10-year rose to 2.27%. That was what it was in January 2009, just after Ben Bernanke began his disastrous ultra-low rate fantasy (as if you could actually make people better off by falsifying the cost of capital!)…the proximate cause of today’s financial distress….
When the whole fake hullabaloo comes to an end … then, we suddenly sober up, look for our car keys….and try to remember how to get home.
The party is over, and the road home looks pretty dark right now. It’s a long road with twists and turns in that kind of bad weather you get during transitional periods when the season changes. This one is likely the biggest change any of us have ever been through as the Fed continues to be forced by inflation to change from its money-printing regime to a money-destruction regime, sucking the air out of the economy’s lungs with a vacuum cleaner, instead of pumping it in with a ventilator, and as it continues to climb in interest rates to fight the inflation wraiths that fly around us. We are entering the time of the undead.
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