Cross-Currents

Welcome to Indicators and Insights. Every Friday, I write about what I find to be the key financial market topics, charts, and stories of the week, often challenging the conventional wisdom.

Subscribe to my newsletter to be notified of new articles, and join the conversation!

This week I discuss the cross currents that are making it difficult to formulate an opinion on rates market direction and I highlight the converging macro risks that could make for a bumpy ride into year-end.

?? ?? ??

With so many cross-currents at play, this is a difficult environment in which to formulate an opinion on rates market direction on both an intra-day and medium-term basis. The good news is that we don't need to right now - it's keeping yields range bound.

FOMC

The Fed has signaled a major policy shift away from using preemptive rate hikes to get ahead of any inflationary pressures to a willingness to maintain an easing posture even as inflation firms up above the 2.00% target.

The FOMC is now targeting maximum employment as the key component of its inflation targeting program. R.I.P. Phillips curve. The Fed is no longer worried that persistently full employment will lead to runaway inflation. Policy makers will, however, continue to add liquidity/ease to drive the unemployment rate down even if inflation moves above the 2% target.

This shift to maximum employment and flexible average inflation targeting, officially announced by Powell on Aug 27 at the virtual Kansas City Fed Economic Forum, was telegraphed earlier in August and drove the 30yr yield up from 1.163% on Aug 6 to 1.574% on Aug 28.

That move, and the concurrent +25bps steepening of the 5yr/30yr curve, must have spooked the Fed Chair a bit because he felt the need to remind market participants in an interview with NPR last Friday (9/4) that yields will be low for years.

But it's going to be a long time, we think. We think that the economy's going to need low interest rates, which support economic activity for an extended period of time, and — It will be measured in years, yes, we believe. However long it takes, we're going to be there. We're not going to prematurely withdraw the support that we think the economy needs.

Jay Powell 9/4/20

Technical Flows

By that time, yields had already corrected down from the late-August highs, however, with technical buying getting that move started and the -10% downside correction in the Nasdaq Comp extending the move in rates to the downside late last week.

Economic Fundamentals

Also Friday a week ago, the strong August employment report was released in another sign that the strength and speed of the recovery has surpassed even the optimistic expectations. The Fed wasn't expecting to see the unemployment rate fall below 10% before year-end. It improved to 8.4% in August with four months to go.

Naturally, rates bounced strongly on the report . . .

Deluge of Supply in Treasury and Corporate Debt

Through it all, Treasury announced aggressive monthly increases in fixed coupon supply during the August quarter. We're in the midst of this supply deluge now. The U.S. Treasury auctioned $108bln total of 3yr, 10yr, and 30yr supply this week. The Treasury supply has seen varying degrees of success - two of the three auctions received a cold reception.

Based on Treasury's August Quarterly Refunding Statement, Treasury will issue $864bln of fixed coupon securities across the yield curve from Aug-Oct.

On top of that, corporate issuers (investment-grade) continued to flood the market with supply as they take advantage of the cheap cost of funds. $70bln priced last week taking the '20 ytd total to $1.44T (vs $865bln ytd '19). The corporate supply has attracted strong demand.

The Wildcard

The big unknown is whether the steep downside correction in the stock market is the beginning of a deeper correction or is simply relieving the pressure valve from an extremely overbought and over-extended market, particularly in the big tech sector.

By the looks of it, it has been the start of a deeper downside correction. The broad market moved higher on Thursday and Friday mornings but was unable to sustain the move. The S&P 500 and the Nasdaq Comp both traded to new lows for this correction on Friday afternoon suggesting more downside to come.

Whatever the case may be, the recent equity move has done technical damage. Long-term trend lines have been violated. Key moving average support has fallen to selling pressure. Even after a 11% downside correction, the slow momentum studies are only now beginning to turn down after being pasted at overbought extremes for six weeks.

Yield Ranges

These are the cross-currents that have been influencing the intra-day flows in the rates market. They will continue to have an impact. Because they are competing forces, yields have been moving sideways in a broad range and, more recently, a more limited interior range as illustrated on the chart below.

Other Macro Factors Converging

There are other developing factors that have the potential to cause elevated volatility in rates and in stocks, commodities, and foreign exchange. This, in turn, will lead to cross-sector flows as we move through the Fall. They include:

• The U.S. and Global economic recoveries are at risk of sputtering
• The U.S. Presidential and Congressional Elections
• The potential for an extended delay (months?) in tallying the mail-in results
• The potential for a contested election
• The real risk of elevated civil unrest and aggression after the election due to a delay in the results, outrage at the outcome, and/or opposition
• The Fall/Winter influenza season coalescing with another seasonal surge in Covid-19 and the strains on the medical system, not only in the U.S., but globally
• A trusted vaccine tested, manufactured and distributed (??)
• Geo-risks including the U.S./China cold war, the U.K. crashing out of the EU without a trade deal, Sino-India military tensions at the disputed Himalayan border, the South China Sea, Taiwan, Hong Kong, political uncertainty in Japan, Iran, North Korea. The list goes on.

Everything highlighted in this article is converging in the second half of 2020. With so many critical factors battling for attention, the global markets are in for a bumpy ride into year-end.

Where all of this leads us is up for debate. It would be best to let the price action in the stock market and in the bond market be our guide as we navigate through the storm clouds.

For yields, the prudent thing to do is to respect the recent ranges defined as the Aug 28 yield highs at .786% on the 10yr and at 1.574% on the 30yr as key support (yield resistance) and last Thursday's yield lows (9/3) at .602% on the 10yr and at 1.318% on the 30yr as key resistance (yield support) . These are the key near-term range boundaries to monitor amid all of the cross-currents.

A move beyond either of these boundaries will indicate something more meaningful has materialized.

? ? ?

This article is part of my LinkedIn Newsletter Series: Indicators and Insights – Perspectives on the Top Financial Market Movers with a View of What's to Come.

To subscribe to “Indicators and Insights" and get notifications of new posts, click the blue subscribe button on the top right hand on this page. Please feel free to share this, leave comments, or direct messaging me with your thoughts about this or any other article or post.

For more content, analytics, or information, please visit The Mitchell Market Report

This report represents the opinions of its author. It reflects market and financial information that we have obtained from third party sources; we believe it to be accurate, but we make no warranty to that effect and are not responsible for any inaccuracies in the information presented. Nothing in this report constitutes personalized investment advice to any reader or a solicitation to effect or attempt to effect transactions in securities. All investments involve risk. Past performance may not be indicative of future results. Due to various factors, including changing market conditions, the opinions set forth in this report may no longer reflect the current views of the author. The author is not an investment adviser, law firm, or accountant, and nothing in this report should be construed as investment, legal or accounting advice. Additional information is available upon request. Copyright (c) 2020. All Rights Reserved. The Mitchell Market Report,LLC