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The Yield Curve Just Inverted

What’s in Today’s Report:

  • The Yield Curve Just Inverted (Chart)
  • Did the Tariff News End the Pullback?

Futures are sharply lower as investors digest historical moves in the bond market amid disappointing economic data.

The 10s-2s yield spreads in the U.S. and U.K. inverted for the first time since the financial crisis while the 30-Yr Bond yield hit fresh lows, further stoking fears of a looming recession.

Chinese Industrial Production (4.8% vs. E: 5.7%), and Retail Sales (7.6% vs. E: 8.5%) both missed expectations as did Eurozone Industrial Production (-2.6% vs. E: -1.5%), adding to the downside pressure on global equities this morning.

Today, there is one second-tiered economic report: Import and Export Prices (E: -0.1%, -0.1%) but because it can offer insight on inflation trends, the release could potentially move markets, as if it runs hot, it could further invert the 10s-2s yield curve spread which is one of the key factors weighing on markets today.

To that point, investors will be closely focused on the bond markets today as the historic inversion of the 10s-2s spread and the drop to new lows for the 30-year yield will likely weigh on risk assets as the odds of a looming recession just increased significantly.

Key Levels To Watch in the Yield Curve

What’s in Today’s Report:

  • Signals from the “Smart Market” – Good, Bad, and Ugly Scenarios

Stock futures are flat to slightly higher this morning as investors continue to digest mixed earnings reports, incremental progress between the U.S. and China on trade, and yesterday’s very dovish Fed chatter.

U.S. and Chinese officials held phone conversations last night and it appears more face-to-face meetings are likely in the near term, underscored by a near 2% rally in copper this morning.

Looking into today’s session, there is one economic report to watch: Consumer Sentiment (E: 98.6) and two Fed officials are scheduled to speak: Bullard (11:05 a.m. ET) and Rosengren (4:30 p.m. ET).

Earnings will remain in focus as there are several notable companies releasing Q2 results before the bell: BLK ($6.52), KSU ($1.61), AXP ($2.05), and SYF ($0.96), but yesterday’s rally was all about dovish Fed expectations so investors will be watching for any further clues as to whether the Fed will cut by 25 or 50 basis points at the July FOMC meeting.

Digging Deeper into the Yield Curve

What’s in Today’s Report:

  • Digging Deeper into the Yield Curve

S&P futures are rebounding solidly this morning after Secretary Mnuchin reiterated that a U.S.-China trade deal is 90% complete while oil prices surge ahead of weekly data.

WTI crude oil futures are up nearly 2% after the API reported a weekly supply draw of over 7M bbls late on Tuesday which nearly tripled expectations (-2.6M bbls).

Economically, the German GfK Consumer Climate headline fell to 9.8 vs. (E) 10.0 in July, underscoring investor concerns about the EU economy.

After Mnuchin’s comments this morning, market focus has returned to the trade war and investors will be looking for any additional commentary out of Washington regarding the upcoming meeting between Trump and Xi or any other details on trade.

There are no Fed speakers today but there are two economic reports to watch that could potentially move markets, especially given the less dovish Fed speak yesterday: Durable Goods Orders (E: -0.1%) and International Trade in Goods (E: -$71.5B).

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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