In terms of qualitative narratives, there's a lot of mixed messaging coming out of the traditional financial media these days regarding the health of the US economy.
On one hand, we have the fact that the United States Federal Reserve (i.e. central bank) raised interest rates only five months ago - an action which is normally taken when the underlying economy is theoretically strong, and expected to get stronger.
Looking at Gross Domestic Product (GDP) in the United States, which is a measure of the goods and services produced in the region over a period of time, the last few quarters have shown sustained growth of at least 2%, which is pretty solid.
Alongside the above data, jobless numbers in the United States have also been extremely low in recent years, across the last two Presidential administrations. The current unemployment rate in the United States is around 3.6%, which is roughly a five-decade low.
When Barack Obama assumed the Presidency in 2009 during the heart of the Financial Crisis, the unemployment rate climbed as high as 9%, before a steady decline to roughly 4.3% during his second term. The unemployment rate has tracked marginally lower, from 4.3% to 3.6%, since Donald J. Trump was elected President.
Taken in sum, the above numbers outwardly suggest that the underlying US economy is fairly strong. But that’s also where mixed messaging enters the equation.
Recent headlines, as well as some hard data, are starting to indicate that the US economy may be weakening, and that a recession may be on the horizon. Although exactly when, and to what degree, are almost impossible to predict.
The foundation of current concerns relating to the US economy stem from the ongoing trade war with China. This conflict has already put the pinch on American farmers, with the prices of many agricultural commodities declining and farm bankruptcies on the rise.
If the trade war continues, many global economists are predicting a decline in global economic growth. In that scenario, it’s hard to envision the United States escaping unscathed.
Backing up these concerns are some hard numbers - particularly the interest rates which make up the US yield curve. The yield curve represents interest rates over time and is typically presented in chart form.
As you can see in the graphic below, the shape of the current yield curve shows a flat to slightly inverted shape:
An inversion (like the one illustrated above) occurs when longer-term rates dip below short-term rates, and is often interpreted as a sign that an economic recession may be on the horizon. The first real warning came in December of last year, when the yield curve experienced its first inversion since 2007.
Since the onset of Spring, further drops in long-term interest rates have underscored growing expectations that the economy may be faltering. The 10-year Treasury rate, which is widely followed due to its impact on mortgages, is down a full percentage point since November 2018, and got as low as 2.13% in early June (and may go lower).
More context on the 10-year is provided by the 30-day Treasury Bill rate, which stands at about 2.35%. That's typically not a great sign - when you can get a better return tying up your money for 30-days (2.35%), as compared to 10-years (2.13%).
Looking down the road, the futures market appears to be pricing in a strong likelihood for two rate cuts by the Federal Reserve between now and the middle of 2020. Rate cuts are usually executed by the Federal Reserve when the underlying economy is weakening. The chairman of the Federal Reserve, Jerome Powell, indicated recently that the US central bank stands ready to provide assistance to the economy, should it falter.
Stepping back, and looking at the complete picture of the US economy, it looks like the mere existence of the trade war is dictating (at least to some degree) future expectations. Hard numbers reflecting consumer and business sentiment simply haven’t fallen to the same degree as economic forecasts - at least not yet.
Given the mixed sentiment, there’s a chance rates could make a big move in the coming weeks or months - especially if the economic needle gets pushed significantly in one direction or the other. That means traders of interest rates and bonds will likely be following the release of economic data very closely during the foreseeable future.
As a reminder, interest rates and bonds share a strong inverse correlation, which is why there have been reams of headlines heralding the “bond rally” of late, as longer-term interest rates have declined.
If you are looking to learn more about the current interest rate environment, we recommend tuning into a new episode of Futures Measures focusing on this very subject.
For a primer on the relationship between interest rates and Treasury futures, a previous blog post may also be of interest - Your Guide to Interest Rate Futures.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
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