15 Aug 2022

The US Treasury curve inversion

There are a lot of measures of yields and discount curves. Looking at raw T-bill yields is not ideal, because they have cash flows at all sorts of dates. However, there is clearly a material difference between the duration of the 10Y note and the 2Y one, and if you track that over time it does tend to signal trouble ahead.

We are now facing trouble.

Wrap

Oil and other commodites slumped. Near month of WTI dropped 3.2%. Coal and gas were up, but mostly commodities were down. The further dated futures didn’t go down much. It’s dangerous to read to much into this (I think the market makers just widen their spreads on the more illiquid contracts on a day like this, without having a settled view of how the forward curve is likely to change shape).

Equities were more or less uniformly bullish. Does this mean we’re in for a recession? Possibly: stocks actually can go up in a recession. After all, labour costs and debt service costs are likely to go down. Sales to but …

The 10Y yield went down 5bp. It is now around 2.8%. Supposedly, the long-term rate is the same as R-star (R*) beloved parameters of the Fed models.

The BoE published a great paper breaking down the drivers behind Global R*, the equilibrium real rate at which the global economy can deliver its potential growth

In short, the world needs negative (!) real yields to hold steady due to very bad demographics and poor productivity pic.twitter.com/b2rK46E2kX

— Alf (@MacroAlf) August 14, 2022

Michael Burry bought $GEO, a private prison stock, and sold everything else. ‘Big Short’ fund manager Burry dumps portfolio, buys prison stock

I haven’t a clue where the stock market is going, but I feel that it’s due for a violent correction. Maybe it’s time to go long volatility with some one- or two-month tight strangles or straddles on SPY or similar. Implied vols on US equities seem very low.

Personal Thoughts

Unions have been purged from low-entry-barrier jobs the private sector. The resulting collapse in the share of income received by the working class (‘middle class’ in US-speak) has been huge.

Strangely, or not, unions have thrived in the public sector, and in some so-called professions. Luigi and Bethany discuss this in their latest Capitalismisn’t podcast. Luigi is very eloquent in his contempt for the American Medical Association (the US equivalent of the BMA) in making reform of the dysfunction US healthcare system. (I am not an expert on US politics, but this take) seems completely wrong. If Obama did a good job in reforming US healtcare, I hate to think what it would look like if had done a bad job.

Unions leaders are generally dinosaurs, from central casting. No wonder young people do not join them. They have a terrible reputation as employers themselves, and when they make gains for their members, it’s always at the expense of the public, whose self-interest is always too dilute to resist their efforts successfully.

It will be very interesting to see what happens if unions manage to make some inroads into Amazon and Starbucks facilities.

As I frequently say, a red-hot labour market is the best possible support for employees. I desperately hope that stupid central bankers do not do what they always do when labour markets are strong and create a recession just to ‘cool’ the labour market. Somehow, central bankers never seem to think that asset markets need cooling.