It was Ernest Hemingway who wrote the infamous sentence “How did you go bankrupt?" Two ways. Gradually, then suddenly” and I think traders can sympathise with this view, particularly after last night’s shock to the system.
We’ve witnessed bond yields gradually rise since interest rates started going up round the world, but then barely a month after Fed chair Jay Powell talked about disinflation, he suddenly comes out with a renewed hawkishness. This has pushed yields up on the short-end to the point where we have a 1 percentage point-plus yield curve inversion: a sign that screams recession.
Share prices are down and there’s a fire under the US dollar now. We now might see the Fed slam the US economy hard just as higher rates start to take effect. It won’t be pretty.
This morning, European stocks have taken their cue from Wall Street and were broadly lower. The FTSE 100 was below 7,900, down around 0.25 per cent. The DAX is flat but CAC 40 is down 0.3 per cent. This was after the Dow Jones dropped 1.7 per cent, taking it into negative territory for the year. The S&P 500 fell by more than 1.5 per cent to 3,986.37 – below the key 4,000 level - and the Nasdaq was down 1.25 per cent. Bank shares led the decline as investors fretted over recession. It doesn’t stop there. Crude prices fell sharply as Powell’s hawkishness implied US growth slowing down and hitting demand.
Front-end bond yields jumped. The 2-year rose above 5 per cent and the 10-year was struggling to breach 4 per cent...leaving a huge 100+bps inversion. It gets worse, Powell is back in front of Congress later on today.
It all started when the Fed chair told Congress there was “little sign of disinflation” and that the “ultimate level of interest rates is likely to be higher than previously anticipated”. He also said the Fed would be “prepared to increase the pace of rates” should incoming data warrant it. It looks as though the Fed was premature to slow the pace of hikes. Now the Fed looks erratic which introduces further volatility, which is sub-optimal when you are already at quite elevated levels of interest.
The market now expects a 0.5 percentage point rise in the US this month, soon after it had settled into assuming a 0.25 point rise. The key now will be data – the Fed is still data-dependent. The jobs report on Friday is now huge. Today we’ll get ADP non-farm payroll data, hardly a great indicator but it will be watched closely.
Neil Wilson is chief market analyst at Finalto
