Published September 14th 2022

Daily Brief - Is CPI declining too slowly?

TL;DR

It’s been an absolute rout in the US Treasury market in August. 10-year yields are marching back towards the highs in June (when, coincidentally, equities bottomed along with Treasuries …) However, the yield curve has remained stubbornly inverted as the front end yields moved even higher. What does that mean?

graph

One-handed economist

“All my economists say, ‘on the one hand...on the other” fumed the American president Harry Truman. “Give me a one-handed economist.” Unlike the dismal science, yield curve is seen as a much more objective - and, importantly, accurate - predictor of business cycles.

Generally, a yield curve inversion has been followed by a recession within 12 months: five out of the past six, by one count. Look at the chart below: every meaningful curve inversion is followed by the ominous shaded area highlighting a US recession.

10y treasury graph

Although its recession prediction is far from perfect, it has been better than most economists. And recently, it inverted right before two of the biggest global calamities: the Global Financial Crisis in 2008 and the COVID pandemic in 2020.

What does it actually mean?

The underlying assumption for the yield curve's ability to predict recessions is that the two ends of the curve are set separately: the Fed sets short-term rates with its fed-funds target while yields of lengthier maturities are set by the market expectations.

The inverted curve reflects market conviction that, to tame inflation, the Fed will ultimately have to tighten financial conditions further and push the economy into a recession.

And how about equities?

Curve inversion is not (in itself) a sell signal for equities. However, it does usually signal outperformance of higher quality assets. Global stocks have typically gained about 8% in the 12 months following the last four inversions of the US 2s10s curve, according to Morgan Stanley research.

For example, US Utilities and Healthcare outperformed the S&P 500 by 6-8%, signs of late-cycle defensiveness working. Finally, late-cycle periods can be good for commodities, especially oil, as has been the case here (albeit for geopolitical reasons).

The most obvious economic repercussion for US stocks will come through an earnings slowdown. As noted in yesterday’s Daily Brief, however, it’s only when such declines turn extreme that stocks begin to pay attention.

Idea Spotlight: Tesla

Analyst expectation indicators for TSLA:NASD are low and historically, this led to a median increase in price of 21.34% over the following 3M. TOGGLE analyzed 5 similar occasions in the past to produce the median projection and this insight received 6 out of 8 stars in our quality assessment.

Tesla executive Martin Viecha spoke at the invite-only Goldman Sachs tech conference on Monday - he laid out the company's next 5 years.

tesla price history

Daily Brief - Is CPI declining too slowly?

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