It’s been a tough few weeks for us bond bulls, that much is for sure.
Not to mention this power surge in the stock market — even with the hawkish Federal Reserve. So hawkish, in fact, that we are up to 70 per cent odds of seeing a 50-basis point hike at the May Fed meeting. Investors may well be pricing in the end of the war and realizing that, no matter what, Putin comes out the big loser. That takes the allure out of safe havens, including gold.
Same thing for the pandemic — investors are looking in the rear-view mirror, with tremendous excitement over the looming travel and tourism spending binge.
Tack on Fed chair Jerome Powell’s assurances that the part of the yield curve he looks at (out to 18 months, who knows why) is gung-ho on growth — and his soothing words that he can engineer a soft landing (investors seem to believe him).
At the same time, there is a tremendous volume of Wall Street research being published and distributed over how the yield curve doesn’t matter any longer. This is one prediction I managed to get right! Several pieces discuss distortions caused by quantitative easing and yet the Fed was busy buying the whole curve — the front end, the mid-part and the back end.
Meanwhile, it’s not so much about the inversion for some segments of the yield curve, but its overall flat shape, which is signaling, with a near-perfect track record, at least a 2-percentage point slowing in U.S. real GDP growth in the coming four quarters.
From the first quarter estimated starting point, that takes us to high-odds of a minimum of 1-1.5 per cent real GDP growth by year-end, far below the Fed’s 2.8 per cent median projection — and that is otherwise known as a growth recession. And one in which the unemployment rate closes the year closer to 4.5 per cent than the Fed’s call for 3.5 per cent. It is against that backdrop that I still find it hard to believe that we see 150 basis points of additional rate hikes this year, despite today’s narrative and what is currently priced into markets.
As an aside, one commodity that has nothing to do with Ukraine or supply chain issues in Europe or Asia, is lumber. And to scant attention, lumber prices have slumped 25 per cent since the beginning of March (and are no higher today than they were last April). Not much inflation here — and what do you think that’s telling us? Mortgage rates? Housing turndown?
I can tell you one sector that isn’t rallying — and it’s the S&P 500 homebuilding index (flat on Tuesday, down 3.5 per cent on Monday, and down 22 per cent from the peak). This is what a 50-basis point surge in mortgage rates can do at a time when the price-to-income ratio for residential real estate (8x) is as bubbly as it was during that manic period of history in the mid-2000s. The Dallas Fed just published a report that the economy is likely heading for a recession that will resemble what we saw in 1991 (following an inverted yield curve — what do you know?? — and an oil price shock).
Look, never mind debating the yield curve. We have gone into a contraction in real economic activity 90 per cent of the time in the past when both fuel and food prices have shot up as much as they have already. The overall economy is not in recession yet, but incomes are, even with the “hot” jobs market. That’s because in real terms - and recessions/expansions are determined by real (not nominal) variables - wages have contracted in each of the past five months and in six of the past seven (this landed the economy in an official recession 75 per cent of the time in the past).
So, ignore the yield curve, sure — but recognize that this cost-push price shock has triggered recessions in the past, more often than not. The Chicago Fed also published a report taking a holistic approach to the labour market and concluded it is tighter than it was at the 3.5% unemployment rate lows that defined the peak of business activity in late 2019, and this is what the Fed is being forced to respond to (keep in mind, that the real message from the Chicago Fed is that the labour market has hit the proverbial wall and there is nothing more end-of-cycle than that prognosis).
As for the trillions of “excess savings” (a Wall Street term for the consumer that has no real definition), they are being siphoned into the gas tank. Just as the summer driving season approaches, gasoline prices have hit record highs these past two weeks (and have been rising now for eleven weeks in a row) to US$4.32 per gallon on a nationwide average basis. Tack on the food crisis to energy, and we are talking about a 2 per cent hit to discretionary spending, which is enough to tip the odds for a consumer recession — unless the household sector does end up dipping heavily into its “rainy day” fund (that came courtesy of last year’s Biden-led untargeted stimulus checks).
Let’s just say that, at 2.38 per cent, we are now just 2 basis points away from the 10-year T-note yield fully pricing in everything that the Fed says it is going to do through this tightening cycle. The fact that there are no doves left on the FOMC is now fully priced into bonds; stocks and corporate credit comes next.
How can the bear market in the S&P 500 be over when it never began?
David Rosenberg is founder of Rosenberg Research, and author of the daily economic report, Breakfast with Dave.
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