Fears of an inverted yield curve racked the markets during 2018’s fourth quarter sell-off, but they returned on Friday as the short-term 3-month and longer-term 10-year yield curve did as such–unveil an inversion that hasn’t been seen since 2007–just ahead of the financial crisis.
This helped send the Dow Jones Industrial Average south by over 300 points in Friday’s early trading session.
“Could it be that the yield curve is signaling weak global economic growth and low inflation without necessarily implying a recession in the US? We think so, and the US stock market apparently supports our thesis,” Ed Yardeni of Yardeni Research said in his morning note Friday. “So why are global stock markets also doing so well? Perhaps there is too much pessimism about the global economic outlook.”
The spread between the 3-month and 10-year notes fell below 10 basis points for the first time in over a decade. This strong recession indicator contrasted a more upbeat central bank on Wednesday, but investors were quick to sense the cautiousness.
During Wednesday’s interest rate announcement by the Fed, Chairman Jerome Powell gave mention to the strength of the economy, but did acknowledge that economic concerns exist domestically and abroad.
“We continue to expect that the American economy will continue to grow at a solid pace in 2019 although likely lower than the very strong pace in 2018,” said Powell. “We believe our current policy stance is appropriate.”
“Since last year, we’ve noted some developments at home and around the world that bear our close attention,” Powell added. “Given the overall favorable conditions in our economy, my colleagues and I will be patient in assessing what, if any, changes in the stance of policy may be needed.”
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In move that was widely anticipated by most market experts, the Federal Reserve on Wednesday elected to keep rates unchanged, holding its policy rate in a range between 2.25 percent and 2.5 percent. The capital markets initially expected rates to remain steady after the central bank spoke in more dovish tones following the fourth and final rate hike for 2018 last December.
“Patience” has been a recurring keyword in Fedspeak since the December rate hike that reappeared in January when the central bank elected to keep the federal funds rate unchanged, saying that it will be patient moving forward with respect to further rate adjustments. Moreover, the Fed has also been saying that it will be mostly data-dependent and have more flexibility when it comes to interest rate policy decision-making.
U.S. equities have been on the rise in 2019 thus far, but the capital markets are conflicted in terms of whether it’s an extension of the bull market that reached fever pitch in 2018 or the beginning of a slide that may have started near the end of 2018.
“The market is polarized: Half thinks we are in a bull market recovery and the other half thinks we are in a bear market rally,” said Eoin Murray, head of investment at asset manager Hermes.
What can mute the jitters and re-instill confidence in the markets?
“It will come down to the U.S. consumer. That’s the last thing that’s holding us up,” Boockvar said. “We’ll need a decline in the stock market to tip over the consumer. So if the stock market can hang in, I think the U.S. can continue to see some growth. If we start to go back to the December lows again, that could be enough to tip us over.”
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