May 30, 2019

Axios Markets

Dion Rabouin

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Situational awareness:

  • Disney CEO Bob Iger said it would be "very difficult" for the company to film in Georgia if a new abortion law takes effect, because many people will not want to work in the state. (Reuters)
  • The Justice Department wants T-Mobile and Sprint to start a new wireless carrier as a condition to clearing their $26.5 billion merger. (Bloomberg)
  • The U.S. fell to 3rd place in a ranking of the world's most competitive economies, with Singapore taking the top spot. (CNBC)
  • Uber will issue its earnings report today along with Costco, Dell, Gap and Dollar General, amid what continues to be a dismal earnings season for retailers. (Bloomberg)
1 big thing: It's beginning to look a lot like 2006

Illustration: Lazaro Gamio/Axios

The difference between the yield on 10-year Treasury notes went further below the yield on 3-month bills Wednesday. The difference is the most since 2007 and suggests that the inverted yield curve may not be going away.

Why it matters: Since the 1970s, an inverted yield curve has preceded every U.S. recession. However, economists, fund managers and other experts have been waving off the inversion's importance so far this year in a way that's eerily familiar.

What they said: When the yield curve inverted in January 2006, in much the way it has this year, former Fed Chair Ben Bernanke said not to worry. "In previous episodes when an inverted yield curve was followed by recession, the level of interest rates was quite high, consistent with considerable financial restraint," he said in a speech in March 2006. "This time, both short- and long-term interest rates — in nominal and real terms — are relatively low by historical standards."

  • Bernanke's predecessor, Alan Greenspan, labeled it a false indicator, noting that long-term yields were being held down by heavy investor demand, just as they are now.
  • The Wall Street Journal's Greg Ip wrote in January 2006 that it was foreign buying of U.S. bonds and exceptionally low yields on U.S. Treasuries (then about 4%, compared to today's yields which are closer to 2%) that was causing the inversion.

It wasn't just 2006 when experts were sure things were different this time.

"We said the same thing in 2000," Bank of America trading strategist Gerald Lucas quipped to the FT in January 2006, while noting that "the inversion was the result of scarcity value at the long end of the curve to do with Treasury buybacks."

Be smart: The experts also insisted that economic data was strong and the usual recession warnings signs — other than the inverting yield curve — simply weren't there.

"I think it sometimes portends a recession, sometimes not," said Marshall E. Blume, a finance and management professor at the University of Pennsylvania's Wharton School. This time, it probably does not, he added in 2006.

  • "All the forecasts are quite favorable. There aren’t any real excesses in the economy at the current time."
Bonus: Then and now
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Data: Federal Reserve Bank of St. Louis; Chart: Axios Visuals

The yield curve inversion is an indicator of conditions that lead to recessions, not a cause, and the timing between an inverted curve and a recession has varied significantly over the last 50 years.

Details: The 10-year/3-month yield curve inverted in mid-January 2006 and the U.S. didn't enter recession until December 2007. During that time the curve briefly righted itself and then inverted again in July 2006 and remained that way until late May 2007.

  • During that time the 10-year/3-month curve was negative by as much as 60 basis points.
2. Stocks and bond yields hit lows around the globe

There was more blood on Wall Street Wednesday. Stocks and other risky assets fell while traders piled into safe-haven bonds.

  • The S&P 500 fell to its lowest since March 11 with the Dow hitting its lowest since Feb. 11 and the Russell 2000 closing at its lowest since Jan. 30.
  • The Stoxx Europe 600 Index fell 1.4% to the lowest since Feb. 21.
  • The MSCI All-Country World Index declined 1.1%, the lowest since February.
  • The yield on 10-year Treasuries touched the lowest since September 2016.
  • Germany's 10-year government bond yields hit their lowest in about 3 years.
  • Benchmark 10-year yields on Japanese government bonds fell to the lowest in almost 3 years and had the largest decrease in almost 6 weeks.

What they're saying: "The 2019 rally has been driven by 1) A dovish pivot by the Fed (no more hikes), 2) An expected U.S.-China trade deal, 3) Stable U.S. and global economic growth and 4) Better-than-feared earnings. Three of those four factors got significantly worse last week," said market analyst Tom Essaye in his Sevens Report newsletter.

  • "The 2019 rally can likely survive the loss of any one factor (which is why the breakdown in U.S.-China trade hasn’t caused a deeper correction), but it likely cannot withstand the loss of any two factors. Right now, we have three of the four teetering."
3. But Latin America bounces back
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Data:; Chart: Axios Visuals

Wednesday's sell-off pulled equity markets around the globe lower, with the notable exception of Latin America.

  • An MSCI index tracking stock markets throughout the region rose by more than 1% and MSCI's Latin America currency tracker rose by nearly 1% as well.

Why it matters: Typically a proxy for investor expectations of the neighboring U.S. or major trading partner China, Latin America's gains were led by Colombia's Colcap index. The Colcap was the world's top performing stock market from January to late March, up more than 30% at its peak.

  • Stock markets in Mexico and Chile also saw notable gains.
4. What the deadweight of tariffs will cost you
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Reproduced from Federal Reserve Bank of New York; Chart: Axios Visuals

U.S. consumers will actually pay less in tariff penalties or taxes with the imposition of 25% tariffs on Chinese goods, but they'll pay a lot more overall, according to new research from the New York Fed.

The higher tariff rate of 25% will cost American consumers more than $100 billion a year. Most of that loss will come from the deadweight loss of consumers buying more expensive, or less efficient, products because of the tariffs.

The N.Y. Fed's Mary Amiti, Stephen J. Redding, and David E. Weinstein explain:

"[T]he 10 percent tariffs on Chinese imports might cause some firms to switch their sourcing of products from a Chinese firm offering goods for $100 a unit to a less efficient Vietnamese firm offering the product for $109. In this case, the cost to the importer has risen by nine dollars, but there is no offsetting tariff revenue being paid to the government. This tariff-induced shift in supply chains is therefore called a deadweight or efficiency loss."

What's next? A new report from Citi estimates additional tariffs on the list of $300 billion worth of Chinese goods will be much worse for consumers.

  • Goods included will represent 67% of total imports of consumer goods from China, 66% of vehicles, 19% of industrial supplies and 38% of capital goods.
5. Boeing's CEO say he's sorry

Boeing CEO Dennis Muilenburg apologized Wednesday night to the families of the 346 people who died in the two 737 MAX 8 jet crashes that occurred within a 5-month period.

It was the first time Muilenburg made an unqualified apology to crash victims, and it represents a turning point in company strategy.

Why it matters to the market: Boeing's stock has fallen more than 17% since the second crash on March 10 and resulting global ban by regulators. There has been little good news since.

Between the lines: WSJ reported yesterday that "some MAX customers may seek to delay deliveries of their jets further because they have missed some or all of the busy summer flying season while other airlines may want their aircraft earlier than scheduled."

  • Muilenburg told WSJ some regulators may trail others in lifting the flight ban and would not project when regulators might approve the MAX upgrade, saying the company is continuing its dialogue with the FAA.
Dion Rabouin