Friends, For Now

Friends, for now.  Stocks remained fixated on Washington DC, where House Dems and the White House  grew closer to a stimulus agreement.  House Speaker Pelosi extended her deal deadline with hopes that a deal might be struck – still friends, but no benefits yet.

 

N O T E W O R T H Y

 

A steep climb.  It has been a long time since I wrote about one of my favorite topics: the yield curve. Wait, before I lose you, give me a few minutes because this story is slightly different than the one we have been hearing for the past few years.  I am currently working on a client presentation, so I dusted off an old one which seems like it was written in a bygone era.  It was actually from February of THIS YEAR, and boy did it seem dated.  I will spare you all of the obvious descriptions of the virus, the stock market “V”, and the economic “not-quite-a-V”.  This is a story about the mostly boring yield curve.  The chart I am referring to was entitled: “Why is everybody talking about the yield curve?” and over a picture of the changing curve, a headline reads: “The yield curve is flattening”, and it was.  In fact, the yield curve had been flattening for some time leading up to last year.  Recall that the yield curve plots treasury bills/notes/bond yields of different maturities and connects them all in what we call a curve.  It typically slopes in an upward fashion, which makes sense as investors expect to receive greater yields for lending their money for longer periods.  The front end of the yield curve plots a 1-month maturity treasury bill, while the back end plots the 30-year treasury bond.  Though all treasuries are free trading and highly liquid, the front end of the yield curve is principally controlled by Federal Reserve Policy.  When the Fed keeps short term (overnight) rates low, the front end of the curve is pretty much locked on or around the Fed Funds rate.  As we move out in maturities, say between 5 years and 30 years, those rates are more subject to the whims of bond investors like you and me… and pension funds, banks, and insurance companies.  Those institutions buy bonds when they expect the economy to weaken in the future.  The increased demand pushes longer maturity yields down but investors still buy them for their safety and because real yields (which factor in inflation) in a slow growing economy are expected to go up because of low inflation.  Anyway the point here is that when bond investors think that the economy is going to slow down, their buying pushes the back end of the yield curve down, thus flattening the curve.  So a flattening yield curve typically precedes a recession.  In fact, the yield curve may even invert briefly, as it did in the last year… and before almost every recession in recent history.  The flattening yield curve was the big story of the past few years as many were expecting a recession. Of course, nobody could have predicted the self-induced recession that came earlier this year.  Back to the curve, historically the yield curve begins to steepen when the Fed lowers rates (monetary stimulus to tackle a recession) pushing down the front end of the curve.  The lower rates combined with the fiscal stimulus which typically occurs ultimately causes inflation to pick up.  Once bond investors believe that the economy is on a healthy track (even in the midst of a recession), they will sell bonds, pushing yields up.  Higher yields are necessary to compensate for the expected greater inflation. Higher long-maturity yields also mean a steepening yield curve… which typically predates an economic recovery and expansion.  So that slide I was referring to had to be completely re-worded.  It now reads: “Yield curve steepening, hopefully a sign that economic recovery is afoot.” Important side note: nothing in the markets and economics happens in a straight line, so while the recent curve steepening is a positive sign, things can change very quickly… as we have learned many times over the past 8 months.

 

THE MARKETS

 

Stocks closed higher but well off their session highs as investors remain cautiously optimistic about a stimulus deal between Pelosi and Trump.  The S&P500 rose by +0.47%, the Dow Jones Industrial Average climbed by +0.40%, the Russell 2000 Index added +0.25%, and the Nasdaq Composite Index advanced by +0.33%.  Bonds fell and 10-year treasury yield added +2 basis points to 0.78%.  The 3-month / 30-year yield curve ended the session at +148 basis points, +16 basis points steeper than it was a month ago.

 

NXT UP

 

– The Federal Reserve Beige Book will be released this afternoon.  It provides anecdotal information about the economic health across all of the various Fed regions.

– DOE Crude Oil Inventories (Oct 16) is expected to show a decrease of -1.288 million barrels after last week’s -3.818 million draw.

– Today’s Fed speakers include Mester, Kashkari, Kaplan, Barkin, Quarles, and Bullard.

– This morning Thermo Fisher, NextEra Energy Inc, Biogen, Baker Hughes, and Nasdaq beat estimates. Before the bell we will hear from Verizon, Abbott Labs, and AutoNation.  After the close announcements include Whirlpool, Chipotle, Lam Research, CSX Corp, Crown Castle, Tesla, Kinder Morgan, Equifax, Las Vegas Sands, and Xilinx.

 

 

 

daily chartbook 2020-10-21