foxex: Yield!

The Market Sum | Insight after the bell

By Caleb Silver, Editor in Chief

Wednesday's Headlines

1. U.S. Markets Sink as Treasury Yields Fall

2. Why Rare Earth Matters

3. Traders Bet on December Rate Cut

4. Chart of the Day: S&P500 Falls to Key Moving Average

Markets Closed

Dow
25,126.41 -0.87%

S&P
2,783.02 -0.69%

Nasdaq
7,547.31 -0.79%

VIX
18.04 +3.09%

Bitcoin
$8,713.04 +0.07%

US 10-Yr Yield
2.236 -1.41%

U.S. Markets Sink as Yield Curve Flattens

Another day of declines for the U.S. and most global markets as April's bullish sentiment has given way to concerns about future growth and market pessimism.

The ongoing and escalating U.S.-China trade war is still in the headlines, but, as we pointed out yesterday, signs of economic weakness were already appearing on these shores. Purchasing managers are getting skittish about placing future orders, inventories are building and corporate profits are slowing.

The U.S. consumer remains resilient - even bullish - according to Tuesday's report on consumer confidence, but that survey was from April.

Today's concerns are directed at the U.S. Treasury market, where we have seen the 10 year U.S. Treasury and the 3 month U.S. Treasury invert for the third time in two months.

Inverted Yield Curve Alert

The yield on the 10-year U.S. Treasury fell below 2.21%, its lowest level since September 2017. Meanwhile, the yield on the 3-month hit 2.36%. That's what we call a yield curve inversion, and many forecasters say it is a precursor to a recession. The way to think about it is that purchasers of U.S. Treasury bonds think the economic outlook is riskier in the near term (3 months in this case), than it is in the long term (10 years), and should be paid more in interest, or yield, to loan the U.S. money. A more common yield curve inversion is when the 10 year and the 2 year U.S. Treasury yields invert, but the last three instances, including the most recent one, involve the 10 year and the 3 month Treasury. The message to the U.S. from its lenders, "You look awful risky over the next few months."

Historically, when the 10 year and the 2 year yields invert, we get a recession most of the time, but not all of the time. This chart from the St. Louis Fed shows the instances where the inversion precipitated a recession in pink bars.

What's Next?

Unfortunately, we don't know we are in a recession until we are in it, or shortly after. Since a recession is generally thought of as two consecutive months of negative growth, and GDP numbers are finalized months after a quarter actually ends, we need to look in the rear-view mirror to pinpoint when it actually happened.

And just because the yield curve inverted doesn't mean we automatically go into a recession or that the stock market will correct or crash. Economic growth in the U.S. is still above 2%, the job market is very strong and inflation is tame.

All of that can change quickly, though, and a prolonged trade war or unexpected shock to the economy could push us into a deep economic funk.

What about the Fed?

The chatter in many investing circles is around how the Fed will react if the economy worsens and the inverted yield curve lasts for several weeks or months. The Fed has promised patience at every FOMC meeting and has indicated it is not likely to raise or cut interest rates again this year.

The futures market has other ideas, however.

We often check the CME's FedWatch tool to see how options traders are handicapping the likelihood of an interest rate hike or cut in the next several FOMC meetings. We wrote a couple weeks ago that options traders had increased their bets that the Fed will cut rates in its December meeting to just over 40%.

We took a look this morning, and those bets had increased to 87% (see below).

The next FOMC meeting is June 19th. Traders have put a 13% probability of a rate cut at that meeting, so don't expect it. Do expect to hear a lot of questions about the strength of the U.S. and global economies, and whether or not the Fed Governors are starting to lose their patience.

Rare Earth Stocks

Rare earth stocks are getting a lot of headlines these days, and for good reason. Chinese media reported on Wednesday that the country is prepared to cut rare earth mineral exports to the U.S. amid the escalating trade conflict. This threat hits a vital nerve for the U.S., as rare earth metals are crucial components for the production of high-tech hardware, from cell phones and computers to cars and airplanes. China's government mouthpiece, the People's Daily, stated that "waging a trade war against China, the United States risks losing the supply of materials that are vital to sustaining its technological strength." The newspaper went on to say that "China has plenty of cards to play."

On the chart below, we see how REMX, the rare earth strategic metals ETF, popped on the potential reduction of Chinese rare earth mineral supply.

chart courtesy of TradingView

More News:

Teva Pharmaceutical Shares Flag Red With Unusual Trading Activity

Will Tesla Be Taken Over by Ford, Apple or Toyota?

Cypress Semiconductor Stock Tests Highs Amid Takeover Rumors

chart courtesy www.koyfin.com

CenturyLink rose today on news of analysts saying the stock had been oversold.

Phillips-Van Heusen fell more than 6% today on quarterly sales that missed estimates. General Mills is down today on a downgrade from Wall Street analysts citing growth concerns for the company - consumer staples seem to be having a rough moment.

Word of the Day

Inverted Yield Curve

We wrote about this above, obviously, but it's worth reading a bit more about, since this most recent inverted yield curve is the widest inversion since the financial crisis.

"An inverted yield curve is an interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality. This type of yield curve is the rarest of the three main curve types and is considered to be a predictor of economic recession."

Today in History

May 29th is College Savings Plan Day, a day to recognize the tax-advantaged account that allows families to save for their children's educational expenses.

That plan is called the 529 Plan. And it's may May 29 (5/29)! I see what they did there. It's a good day to read up.

Chart of the Day: S&P 500 Plummets to Key Moving Average

As with other major U.S. equity indexes, the S&P 500 (SPX) gapped down and tumbled on Wednesday, establishing a new 11-week low and hitting its 200-day moving average for the first time since early March.

The 200-day simple moving average (SMA) is considered one of the most important technical indicators by traders and market analysts, both for determining the overall market trend as well as potential support and resistance levels. Currently for the S&P 500, if the 200-day indeed serves as support, we could be seeing an impending upside bounce after the ~6% pullback that has been in place since the new record intraday high around 2954 was reached back in early May.

The last time the S&P 500 made a bullish bounce off the moving average was back in early March, after which the benchmark index launched into an aggressive and extended climb that culminated in the new all-time high. Back then, SPX actually made a false breakdown below the 200-day before bouncing sharply above it. This type of a bounce could happen once again, provided the current downturn does not become a bonafide correction (10% or more below recent high) or bear market (20% or more below recent high).