Two-year Treasury spikes signal ‘severe economic slowdown’

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The inverse yield curve is now even more inverse. Unfortunately, the economy appears to be seriously collapsing.

The yield on the two-year government bond rose to 3.87% on Friday from 3.78% on Thursday, and is now above its long-term average of 3.14%. Simply put, when short-term interest rates are higher than long-term interest rates (10-year at 3.45%), it means lenders see more risk in lending today than in lending to someone in the future .

They were warned on August 5th.

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“We are facing a serious economic slowdown around the world,” Edwards Jones investment strategist Mona Mahajan told CNBC’s Squawk Box this morning. “We had an inflation report this week that was hotter than expected… and the S&P also looks weaker from a technical perspective. We need to see the inflation picture improve. The consumer is still in good shape, but we don’t see recessionary conditions.”

We will.

The market is testing the Fed at this point, urging it to hike rates amid an economic slowdown. But given that no one is willing to say the US is in an actual recession – only a technical one – what is stopping the Fed from sticking to its anti-inflation mandate? For them, there really is no such thing as a recession. The labor market is too strong. Unemployment is not even 4%.

You are in a catch 22. If they keep raising interest rates, the economy will certainly slow down as companies become more financially fatigued. The downsizing begins. The Fed then gets its recession and can stop raising rates provided inflation comes down.

“There is nothing but an economic contraction due to the 2-year yield rising above the 10-year yield,” says Vladimir Signorelli, who is taking time off from his cruise to Mexico on Friday. Signorelli is principal of Bretton Woods Research, a macro investment research firm based in Long Valley, NJ.

Higher short-term rates mean higher mortgage rates. This is good for those who want to buy a house and are on a budget. But home prices will have to fall further before a lower sticker price offsets a higher mortgage rate.

Year-over-year, existing and new home sales are down 20.2% and 29.6%, respectively. That’s because the prices are still outrageous. This week, Zillow revised its 12-month outlook and now expects US home values ​​to rise 1.4%. That’s the wrong way. Housing inflation isn’t helping the US economy one bit. Some of this is due to supply chain issues as the US appears unable to produce lumber and bathroom fixtures so it has to import everything by boat from China that is in and out of Covid lockdowns. And European multinational shippers have spent most of the last two years driving up shipping prices. Also not helpful.

As housing construction slows, there are headwinds for construction workers and all those businesses that have been kept alive by government stimulus during the pandemic. That charm is gone. And now the economic rug is being pulled out from under them.

At this rate, unless Titanic’s captains shift hard to starboard, a “deep recession” in core economies is likely, Barclays said last Friday and repeated all week.

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“If Powell doesn’t get a lead, this is catastrophic Federal Reserve policymaking,” Signorelli said.

It’s rare for central banks to hike rates in an economic downturn. But those same banks had interest rates at or near zero when the economy was booming. That’s largely because inflation hovered around 2% on good days. Today it is closer to 9%, even 10% for some items like groceries compared to a year ago.

“Hawkishness with interest rates is being emulated elsewhere, like in Europe, India and Brazil,” says Signorelli. “It’s never good to see half of the world’s central banks decide that they should now do their best to focus on curbing economic growth.”

World Bank President David Malpass recently warned central banks against reversing as a major global recession looms next year. It might be better to focus on boosting manufacturing and economic growth.

“The increasing likelihood that the Fed will doom us into a deep recession in an ill-fated attempt to unbake an inflationary pie based on a bad recipe for 2021 enters the popular narrative,” says Brian McCarthy, head from Macrolens in Stamford.

“My mouth is watering to load up 5-7 year bonds,” McCarthy said in a note to clients Friday afternoon after the close of trading. “The chances of a soft landing drop to zero. Salivate as much as I could… I’m afraid we’ll have to let this stew a little longer.”

The biennial Treasury Department says Wall Street investors — and lenders — think it’s time for a breather.

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