Juggling Dynamite

Hoisington Management’s Third Quarter 2023 Review and Outlook is now available. This is no sugary snack soundbite, but it’s five pages worth digesting. See Impending Recession. Here’s a taste:

The peak in the financial cycle occurred in the fourth quarter of 2021, seven quarters ago. This is right in the middle of the five to nine-quarter average monetary policy lag since World War II.

Monetary conditions have steadily tightened through the end of the third quarter of 2023 and the process is widely expected to hold through the end of the year, and possibly even into 2024.

Historically, these more restrictive conditions will expose, through bankruptcy and liquidation, those who took excessive risk during the monetary largess of 2020 until early 2022.

Through September, the yield curve between the two- and ten-year Treasury yields has remained inverted for over twelve months. As Duke Professor Campbell Harvey’s research has shown, this barometer has, without exception, preceded each of the last eight recessions over the course of seventy years. Such developments point the economy in the direction of an economic downturn and lower inflation

It is not just rapid hikes in the overnight rate (525 basis points in 18 months by the US Fed and 475 basis points in Canada), which are contracting credit and slowing spending through the real economy. The drop in equity and bond prices, along with the jump in fossil fuel costs and the US dollar, have tightened financial conditions the equivalent of an additional 80 basis points in the last two months alone.

US third quarter GDP (first estimate released this Thursday) was boosted by war-time style government spending, but gridlock heading into an election year makes that less likely over the next several quarters.

Canadian GDP already contracted in the first half of 2023 (-.2% annualized), and with August data due on October 31, the second half is not looking up. If the US Fed has done enough with its tightening efforts to date, the case for the Bank of Canada to be done is stronger still. No wonder the loonie has weakened against the Greenback even as oil prices bounced over the past four months.

Indeed, with defaults and bankruptcy surging through the private sector, financial tightening has already been overkill. As central banks pause, the flight to safety and hedge funds covering their shorts on Treasuries will naturally boost the buying of government bonds. This will help ease interest rate pressures, but too late to rescue highly leveraged households and companies, especially in Canada.

The segment below discusses some of these factors.

DiMartino Booth and Charles Payne Break Down the Latest Action in Bond Yields. Here is a direct video link.

In the past few months, short-term treasury yields have risen more than long-term such that the yield curve, which has been inverted since April 2021, is now un-inverting. This move typically signals the near-term onset of recession and the worst stock market losses.

The chart below from my partner Cory Venable shows the move in the US 2-10 yield spread from a deeply negative 108 basis points in June 2023 to -22 this morning. Past re-steepening episodes are highlighted in blue, with the recessions that followed in red.

Komal Sri-Kumar, president of Sri-Kumar Global Strategies, joins ‘Squawk Box’ to discuss rising Treasury yields, with the 10-year Treasury yield breaking above 5% for the first time in 16 years, the impact on markets and economy, the Fed’s inflation fight, and more.Here is a direct video link.