From the HRA Special Delivery: Issue 1225 – Nov. 29, 2023
The past week had one of the biggest changes in market tone we have seen for a long time. The change is exemplified by Wall Street’s recent nemesis, the 10-year yield. The chart below shows the steep pullback in the past few sessions. As I predicted, it was the QRA (Quarterly Refunding Announcement) something I don’t think most had every heard of or paid attention to earlier, that seemed to have the biggest impact.
That came last Wednesday, and you can see the huge downward bar that day. Yes, Wednesday was FOMC day too, but Powell didn’t say anything too startling in his Q&A. Indeed, most considered it to be slightly, but only slightly, hawkish. Certainly nothing to explain the drop in yields. A couple of other Wednesday data points also helped. The ISM Manufacturing PMI was a big miss, coming in at 46.7, way below consensus of 49. That reading implies at least moderate contraction in the goods part of the US economy. And the APD payroll growth number was also a big miss, coming in at 113k, well below the consensus estimate of 150k. We’ve all learned to be wary of the ADP estimate, but they more or less got it right this time, as it turns out.
While the ISM and ADP numbers factored into falling yields, the QRA seemed like the main reason for the drop. I think the reaction backs up the thesis that at least part of the earlier rally in yields was bond traders worried about supply. As it turned out, the US Treasury is planning slightly less issuance this quarter, and slightly more in Q1 2024, but the main news was the mix of durations. The Treasury will be doing most of its fundings with durations of two years or less, and much less than expected at 10 years or more. That took the pressure off 10 year yields immediately, and just about every data point since has helped fuel a further rally in the long end of the curve.
Moreover, Friday’s non-farm payrolls were just what the doctor ordered, for Wall St at least. Like the ADP number, NFP was a significant miss, coming in at 150k, below 180k consensus. More importantly, perhaps, the prior two months were revised down by 101k. As recessionistas will tell you, downward revisions are a late cycle phenomenon. True, though they aren’t much of a timing guide. I’ve stayed out of the “Establishment Survey vs. Household Survey” debate, as I have no edge. They are done differently and generate different data sets. I don’t know which is better, frankly. I’m brining this up because the September Household Survey number was way light, showing a decline of 347k jobs. It’s a volatile reading, but that is the biggest decline since the depths of the covid-19 mini-recession, so its not nothing, presumably.
The other miss in the NFP was the unemployment rate, which came in at 3.9%, above 3.8% consensus. That brings me to yet another recession warning measure, one that is getting a lot of traction lately. The Sahm Rule, created by former Fed economist Claudia Sahm. She wanted a “very near term” recession indicator that would allow her to send a warning across the federal government that it was time to gear up for a big increase in the unemployment, welfare and food/housing assistance rolls because recession was starting. She probably didn’t expect to attract a big following, but she’s getting one because her indicator has a perfect track record when back tested all the way back to WWII. The graph below shows her indicator up to 2019, along with shaded areas indicating recessions.
In essence, the Sahm Rule uses the positive change, and speed, in the unemployment rate as an indicator a recession is starting. It states, “when the three-month moving average of the unemployment rate increases 0.5% from the lowest reading in the prior 12 months, a recession has started’. You can see from the chart above that the indicator jags higher right when recessions start, and it’s got a perfect track record so far.
The Sahm Indicator was near, or below, zero though the past two years. It only started moving significantly higher in the past three months. Based on Fridays NFP, the Sahm Indicator now sits at 0.33%. Should be batten down the hatches? Well, not quite yet. It won’t take much movement higher to generate a 0.5% trigger reading. Increases in the November and December unemployment rate of 0.1% each would do it. So, its worth tracking. I think the indicator will be getting much more press going forward. All that said, its important to note that Sahm herself stresses this is a “close doesn’t count” indicator. Its very possible for the reading to bounce around between 0% and 0.5% but, unless it hits 0.5%, it is NOT triggered. Anything below that is just noise, according to Sahm. You can see plenty of smaller swings on the chart above that did not indicate recession starts. There is also some potential that the UAW strike skewed the October NFP numbers, and this will fade away. We’ll see.
So, is Wall Street back on recession watch? I don’t think so. Recession was predicted for 18 months, and it looks like more and more investment bank economists are backing off their “recession in 12 months” calls. The way stocks are trading, with a 5% S&P and 7% QQQ gain in the past five sessions, it feels like we’re back to a Goldilocks soft landing scenario, Wall St’s favorite.
Who knows, maybe we do get a soft landing, though I caution its not likely. Yes, the long end of the yield curve has come down hard, but its all relative. The current 10-year yield, at about 4.5%, is still at levels that had traders pooping proverbial bricks just over a month ago, so it’s a bit early for a victory lap. Because there will be more short-term issuance, the near end of the curve hasn’t fallen as much. That has widened the 10-2 spread to 35 basis points, good news if that is your recession warning of choice. The flat curve after inversion indicator has not been triggered.
The past week’s action has the bond market certain rate hikes are over, which is probably true. There are also many pulling the date of the first-rate cuts forward, which I think is still far less certain. Most FOMC members giving speeches and interviews this week are still holding firm on their “higher for longer” stance. I still see no reason not to take them at their word, whether one thinks it’s the right policy or not. I’m still not in the recessionista camp, but I agree the odds of one are increasing by the day, and higher for longer, if the FOMC doesn’t abandon it, makes a harder landing all but certain, even if the timing isn’t.
Before I move on, I want to post the chart on the right as a reminder, albeit a very big picture one. I’ve published earlier versions of this. Indeed, it was one reason I expected higher rates a couple of years ago.
This 10-year yield chart goes back to 1992. If you took it all the way back to 1980 it would show the same picture. The trend until 2020 is clear- long term declining bond yields. As I wrote a couple of years ago, this trend dominated everything for almost 40 years, Almost no one around today knows what its like to trade a bond bear market, which is what we’re in now. I didn’t draw a trendline, but I don’t think its necessary. The downtrend was clearly violated, decisively, last year. Remember, this is a secular, not a cyclical, trend. The new world order we’re in now for the bond market could go on for a long, long time.
I agree with everyone that the developed economies can’t handle anything like the rates that prevailed in the 1980s and 1990s. I’m not expecting that. And there will certainly be rate cuts if the US goes into recessions, just as there were during the long downtrend from 1980-2020. But I think the era of ZIRP (zero interest rate policy) or even near-ZIRP is over, possibly for decades if this is the secular change, I think it is. I still don’t know how we square the circle on this, but its hard to see how, at some point, governments don’t throw in the towel and try to inflate the debt away. That is a longer-term argument for much higher weighting for gold in one’s portfolio, but has the last week blown up the short-term scenario?
Because that drop in yields and slightly wilting USD index meant gold price soared since the middle of last week, right? Yeah, not so much. So why are our dreams of bullion dominion dashed once again? First, I’m not sure they are – yet. Much like the drop in yields, its too early for gold bears to be taking a victory lap, though many are. As you can see from the chart below, the drop has only retraced a small amount of the huge rally that preceded it. So far, gold has managed – barely to stay above the 200-day moving average. Breaching that could generate a lot of follow on selling, but we’re not (quite) there yet.
The reaction of the gold price is a classic “risk on” move. Dropping yields generated panic buying of equites. I’ve never liked fear moves in the gold price and the reaction in the past few days shows the rally was at least partially that. Some of that fear was of higher yields choking off the economy, which is why gold prices were moving with yields, not how it normally works. Since the middle of last week, gold is still moving with yields, but this time going down with them, not up.
I think, for the short term, bonds have done most of their rallying. I don’t think they move too much higher unless we get some truly awful economic metrics. And there are a couple of long bond auctions this week. I don’t expect surprises, but bond traders are cocky, so even slight weakness in the auction statistics could kill the bond rally.
Lower rates haven’t led to much of a drop in the US$, though it’s been a little weaker. There was potential for a much stronger Yen after last week’s BoJ meeting, but that potential hasn’t been realized yet. The benchmark 10-year JGB yield rapidly increased to 1% after the BoJ widened the band in its yield curve control to 1% and at least implied it would not even defend 1% that hard. Even so, partially due to action in the US bond market, the Japanese yield fell back to its current level of 0.87%. That’s not enough drive new currency flows and the $US/Yen has held above 150. This is still a potential bullish factor for gold. If something happens to drive JGB yields above 1% I would expect a rapid strengthening in the Yen, which will put a bid under gold. The other major gold support through the past year, central bank buying, continues to be strong. Several central banks, notably the Bank of China, continued to add to their holdings through September. It doesn’t look like this trend will change anytime soon and it continues to help explain gold’s relative strength with so many headwinds.
The one piece of (relative) good news during the past few sessions is that gold stocks have been trading a bit better than gold itself, something that hasn’t happened for a while. The most frustrating thing about the October rally was the lack of response from miners. Its still not great, but we’ve seen the GDX rise on days gold was getting pummelled. The trend would have been clearer had Franco Nevada, an important GSX component, not sold off due to problems at First Quantum’s Cobre Panama. FNV has a royalty on Cobre that generates a lot of revenue, so it got slammed when FM did. Without that impact, recent outperformance of GDX against gold would have been more obvious. It’s not much, but miners leading bullion is often the hallmark of a “real” gold rally. Gold is still in the running if it can get find a bottom before it goes much lower.
Regards for Now,