Yield Curve Inversion Concerns While Coincidental Numbers Remain Strong
Hale Stewart | Dec 16, 2018 02:03AM ET
Leading indicators
The yield curve continues to issue warning signs. This week we had a mild inversion in the "belly of the curve" (the 2-10 year sector):
The 2-Year was a few basis points above the 5-Year for several days (as was the 3-Year), which is better shown on this graph:
The 7-Year to 2-Year spread continues to narrow:
As does the 10-Year to 3-Month spread:
Finally, the long-end of the curve is starting to come in with the 30-Year to 10-Year spead:
Both the 30-Year and 10-year Treasury yield has fallen; the former by about 15 basis points, the latter about 20. This means that over the last month, investors see less growth and therefore less inflation.
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As a result of the Fed raising interest rates and the long-end of the curve tightening, the total yield spread of the curve is now about 75 basis points:
What we have is the classic end-of-the-expansion yield curve scenario. The Fed is raising rates to maintain inflation expectations and contain inflation. This is starting to slow growth, keeping inflation low, making the long-end of the curve attractive. Hence, investors are buying 10- and 30-year Treasuries. The overall effect is to narrow the curve.
h3 Coincidental Indicators/h3The Census issued the latest retail sales report [emphasis added]:
Advance estimates of U.S. retail and food services sales for November 2018, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $513.5 billion, an increase of 0.2 percent (±0.5 percent)* from the previous month, and 4.2 percent (±0.5 percent) above November 2017. Total sales for the September 2018 through November 2018 period were up 4.3 percent (±0.5 percent) from the same period a year ago. The September 2018 to October 2018 percent change was revised from up 0.8 percent (±0.5 percent) to up 1.1 percent (±0.2 percent).
Let's place this data into historical context:
The left chart has the absolute number while the right is Y/Y. The left number continues to move in a SW-NE direction - a solid uptrend. The Y/Y rate is slightly above 4%, where it's been for all this year.
We see the same pattern in the numbers ex-autos, except that the Y/Y pace is at 4.9%.
There are two areas of concern in the data, starting with auto sales:
Auto sales have probably peaked for the cycle. They were moving sideways (left chart) for most of 2018 while the Y/Y number continues to move lower (right chart).
Restaurant sales grew strongly in the first half of the year; they have since moved lower. The Y/Y pace has been like a yo-yo this year.
Next, the Federal Reserve released the latest industrial production numbers. Here is the table from the report:
The headline number was positive. However, the details are less impressive. Manufacturing was flat (lower panel), and as were final products; non-industrial supplies rose .2% (top panel). These are only one month of numbers; however, all of these sub-categories have been advancing nicely over the last year. The real gains were in mining (oil extraction) and utility output.
h3 Conclusion/h3The good news is that two coincidental numbers remain strong. However, the partial inversion of the yield curve is very worrying. The long-end coming in is a classic end-of-cycle development, as is the narrowing of the entire curve. I'm keeping my recession probabilities at 30%.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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