Bull Steepening (Not Necessarily Good for Stocks)

What’s in Today’s Report:

  • The Yield Curve Is Steepening, That’s Good for Stocks Right? (Not Necessarily)

Futures are moving higher on dovish optimism following soft economic data overseas ahead of today’s jobs report but trade war developments were actually negative overnight.

German data disappointed overnight as Industrial Production fell -1.9% vs. (E) -0.5% while the trade surplus narrowed to 17.0B euros, a 9-month low.

The data is fueling hopes of a dovish policy shift from the ECB, however, after Draghi cited soft manufacturing trends as a concern earlier in the week which is helping EU shares outperform this morning.

Trade news was a net negative overnight as Mexican tariffs are still expected to be implemented on Monday (hopes of a delay pushed stocks higher yesterday afternoon) while there were no material developments on the China front.

Today, investors will be primarily focused on the Employment Situation Report due out at 8:30 a.m. ET (E: +180K job adds, 3.7% UR, 3.2% wage growth YoY).

Due to the huge dovish shift in Fed policy expectations over the last week, bad news will be good news for stocks as the odds of a summer rate cut will rise and the biggest risk for stocks is a “hot” print this morning, especially on wages.

China’s Inverted Yield Curve, June 28, 2017

If A Yield Curve Inverts In China, Does It Signal A Looming Recession?

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China's Inverted Yield Curve

Last week, in our post, “Will Chinese Credit Impulse Impact Global Markets?“, I explained how China remains the largest macro threat to the rally as it begins to deflate its massive credit bubble, a credit bubble that has funded asset bubbles across geographies (Australian property, California property, Treasuries, stocks, etc.).

At this point, it’s just a risk, as there are no concrete signs that the Chinese economy is in trouble, although the Chinese bond market is signaling some caution.

First, it’s well known that inverted yield curves predict recessions. Here in the US, the inverted yield curve predicted the ’81, ’91, and ’00 recession, and the ’08 financial crisis (remember the yield curve inverted in ’05, and stayed that way until the Fed started cutting rates in late ’07).

So, it is noteworthy that the Chinese government bond yield curve is essentially flat, and in some cases has inverted. For instance, as of yesterday the three-year government bond was yielding 3.558%, higher than the 5 year at 3.524%. And, the 7 year was yielding 3.626%, higher than the 10 year, which yielded 3.56%. So, while not a total inversion, it is safe to say it’s flat.

Now, before we go running for the hills and sell stocks, we have to realize this is China, not US Treasuries. As such, liquidity distorts this picture somewhat. For instance, 10-year Chinese bonds are by far the most liquid, so they will move more than other issues. Still, this is not the type of yield curve that implies an economy that is healthy. Again, this matters because the last time we got a Chinese economic scare, it caused the S&P 500 to collapse 10% in a few days… not once, but twice in a six-month period.

Bottom line, I’m not saying get defensive, but I am saying that from a macro standpoint 2H ’17 is shaping up to be more bumpy than 1H ’17, and I want everyone to be prepared. We will be watching China closely for you.

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