Inverted US Yield Curve: Should FX Traders Be Worried?

• Housing Starts 1162K vs. 1210K Expected
• Building Permits 1296K vs. 1305K Expected
• S&P Case Shiller House Price Index 0.11% vs. 0.3% Expected
• Richmond Fed Index 10 vs. 10 Expected
• Conference Board Consumer Confidence Index 124.1 vs. 132.5 Expected
• Trade Balance -$51.1B vs. -$57B
• Current account balance -134.4B vs. -130B Expected
• Q4 GDP Revision 2.2% vs. 2.3% Expected
• Personal Consumption 2.5% vs. 2.6% Expected
• Jobless Claims 211K vs. 220K Expected
• Pending Home Sales -1% vs. -0.5% Expected
• Personal Income 0.2% vs. 0.3% Expected
• Personal Spending 0.1% vs. 0.3% Expected
• New Home Sales 667K vs. 620K Expected
• University of Michigan Sentiment Index 98.4 vs. 97.8 Expected

• Retail Sales – Potential upside surprise as gas prices and wages grow strongly in February
• Durable Goods - Durable goods orders are difficult to predict but Boeing (NYSE:BA) orders will certainly be affected by the 2 crashes
• ADP – The private employment report is likely to pull back after diverging so significantly from last month’s NFP
• ISM Manufacturing
• ISM Non-Manufacturing – Will have to see how the manufacturing report fares but slowdown likely given last month’s big NFP miss
• Nonfarm payrolls - Job growth should rebound after last month’s big downside surprise

• Support 110.00
• Resistance 112.00

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Inverted US yield curve – Should dollar bulls be worried?

The biggest story in the financial markets right now is the inverted US yield curve. For the first time since 2007, the yield on the 10-year Treasury note is lower than the yield on 3-month paper and this has investors very worried. The US economy fell into recession 7 times in the last 5 decades and the yield curve inverted before all but one. The reason why yield curve inversion is such an accurate determinant for recessions is because when short term rates exceed long time rates, investors are worried about the near-term outlook for the economy and want more compensation for tying up their money during this time. The stock market tends to peak in advance with bear markets coinciding with recessions.

Should you be worried? NO, in the short term. YES, in the long run.

Throughout the past week, FX traders were yanked around by risk on / risk off flows because investors are having a hard time deciding whether the drop in yields is positive or negative for stocks. On the one hand, lower rates are good for borrowing but on the other, the yield curve inverted as a result of falling interest rates and central bank pessimism. In the past month, every major central bank raised concerns about domestic or global growth and bond traders are finally hearing what they have to say. Equity traders, on the other hand, are still largely ignoring these warnings as US stocks spend the past month hovering near 3-month highs. The mixed performance of the US dollar is a sign that forex traders are not sure what’s more important – risk aversion or US recession. In the short run, there’s no need for panic because there’s generally a long 12+ month lag between the yield curve inversion and a recession. While the stats are all over the place, on average in the past 60 years, during which there were 9 yield-curve inversions, the stock market generally does not peak until 8 months later. This means stocks could hold onto their gains in the near term until the deterioration in the economy becomes more evident. Also, the yield curve can invert, normalize and invert again as it has many times in the past.

In the long run, the historical ramifications of a yield curve inversion are consistent with the Fed and ECB’s warnings of slower growth. There’s a very good chance of a recession in 2020 or 2021. But like stocks, a yield curve inversion is not always negative for the US dollar. The last time the 3-month rate exceeded the 10-year rate was in 2008 and that was right before the Dollar Index soared on risk aversion. Before that in 2006, the dollar fell at the initial inversion but recovered quickly. The same was true in 2000, the dollar index consolidated and then popped higher.

While a yield curve inversion could actually help the dollar, in the near term, the focus will be on Fed monetary policy and whether the economy is really slowing enough to justify the central bank’s decision to cut their interest rate forecast to zero for the rest of the year. How fast the greenback falls will hinge on the upcoming retail sales, ISM and nonfarm payrolls reports. If spending, economic activity and job growth is weak, USDJPY will extend its slide quickly. However, if these reports improve from the prior month, we could see a relief rally.

Australia

• No Data

New Zealand

• RBNZ says the risk of a rate cut greater than a hike
• Trade Balance 12M vs. -200M Expected
• ANZ Activity Outlook 6.3 vs. 10.5 Previous
• ANZ Business Confidence -38 vs. -30.9 Previous
• ANZ Consumer Confidence 0.8% vs. -0.7% Previous
• Building Permits 1.9% vs. 16.5% Previous

Canada

• Trade Balance -4.25B vs. -3.55B Expected
• GDP MoM 0.3% vs. 0.1% Expected
• GDP YoY 1.6% vs. 1.3% Expected

Australia

• RBA Rate Decision – No changes expected from the RBA but investors will be watching for any cautiousness
• AU PMI Manufacturing – Likely to be weaker given slowdown in China’s economy
• AU Retail Sales, Trade Balance and PMI Services – Potential downside surprise given a general weakness in global growth and China

New Zealand

• None

Canada

• IVEY PMI – Possible rebound after last month’s soft read
• Employment report – Likely to be weaker after 2 strong months

Key Levels

• Support AUD .7000 NZD .6700 CAD 1.3200
• Resistance AUD .7200 NZD .6900 CAD 1.3450

Will AUD Break Down on RBA?

Investors are bailing out commodity currencies as concern about global growth grows. These smaller economies are generally more sensitive to a slowdown abroad when their largest trading partners are affected. This past week, we learned that Chinese industrial profits dropped 14% and a decline as large as this could trigger additional stimulus from the central bank. But tax cuts in China go in effect this week and the government may want to see how much they lift the economy before doing more. The Reserve Bank of Australia who has a monetary policy meeting on Tuesday could share this sentiment. Although the Reserve Bank of New Zealand talked easing this past week, the RBA should still reiterate that the next rate move will be up not down. Since February, we’ve seen inflation expectations rise, consumer spending recover and the unemployment rate drop to its lowest level since 2011. These improvements help to offset the decline in business and consumer confidence as well as the deterioration in Chinese trade. So while risk appetite could keep AUD down, the RBA rate decision may help more than hurt the currency. Aside from the monetary policy announcement, we also have retail sales, the trade balance, manufacturing and service sector PMIs scheduled for release. Technically, the pair is range bound with a negative bias and that will remain the case until it breaks above .7150.