Inversion confusion

From: POLITICO's Morning Money - Wednesday Mar 30,2022 12:01 pm
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POLITICO Morning Money

By Kate Davidson and Aubree Eliza Weaver

Presented by Sallie Mae®

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Federal Reserve Chair Jerome Powell has voiced confidence in recent months that the central bank can cool the economy enough to tame rampant inflation without causing a recession.

The bond market doesn’t share his optimism.

Investors briefly pushed the yield on two-year Treasury securities above the yield for the 10-year note on Tuesday for the first time since 2019. The so-called yield curve inversion is seen as an important predictor of a potential economic downturn — or, at least, of future interest-rate cuts — and suggests investors believe the Fed will tighten rates too aggressively and be forced to reverse course.

“At the very least, an inverted curve … is a symbolic message from market participants regarding expectations of a recession,” said Stifel Financial Chief Economist Lindsey Piegza. “With the Fed vowing to raise rates ‘aggressively,’ the risk of a recession has jumped to over 50% within the next 21 months.”

Does that mean a recession is imminent? No. It’s also worth noting that while the 2019 inversion was followed by a recession, that downturn was caused by a global pandemic – hardly something investors could have foreseen. In other words, correlation is not necessarily causation.

Of the 28 yield curve inversions that have happened since 1900, 22 of them were followed by a recession, according to data compiled by Anu Gaggar, global investment strategist for Commonwealth Financial Network, and her team.

But even then, the length of time between inversion and recession was highly uncertain. On average, a downturn occurred within 22 months – but it ranged from six months later to 36 months later, she said.

“It’s not a very reliable timing indicator in terms of when we will see recession,” Gaggar said.

A quick look at the underlying fundamentals of the U.S. economy suggests it won’t be anytime soon.

The labor market is rapidly improving. The number of Americans applying for jobless benefits fell to its lowest level in more than 50 years, the government said last week. U.S. job openings fell slightly in February, but were still well above their pre-pandemic average, a sign that employers are still struggling to hire workers. Wages have climbed at the fastest pace in years, continuing to power household spending despite higher inflation.

While forecasters expect a step down in U.S. economic growth this year, output will be slowing from a blistering pace in 2021, when the economy saw the strongest growth in four decades. Aggregate demand is still strong as are household and business balance sheets, Powell said this month.

“In my view, the probability of a recession within the next year is not particularly elevated,” he said at the Fed’s post-meeting press conference March 16.

Powell also recently pointed to research from two Fed economists proposing that a much better predictor of interest-rate cuts is a measure they call the “near-term forward spread,” based on yields that mature within the next two years. While the spread between two-year and 10-year yields has flattened, the near-term spread has climbed since earlier this year, when officials signaled they were ready to begin raising rates.

“Ultimately, we argue there is no need to fear the 2-10 spread, or any other spread measure for that matter,” Eric Engstrom and Steven Sharpe said in an update to their 2019 paper published last week. “At best, the predictive power of term spreads is a case of ‘reverse causality.’ That is, term spreads predict recessions because they impound pessimistic—often accurately pessimistic—expectations that market participants have already formed about the economy, and thus an expected cessation in monetary policy tightening.”

So why are signs in the bond market flashing red right now?

Gaggar said it may be due in part to how fast this business cycle has unfolded — the economy plunged into a deep recession at the start of the pandemic, bounced back strongly within several months and has been surging over the past year. Now, with inflation near four-decade highs, the Fed is preparing to raise interest rates much faster than many forecasters expected even a few months ago.

At the same time, strong global demand for safe-haven Treasury securities is continuing to keep rates for long-term debt subdued.

“This was bound to happen,” she said of Tuesday’s brief inversion, but added, “The underlying fundamental factors for the economy don’t reflect a recessionary environment yet.”

IT’S WEDNESDAY — What’s your preferred recession indicator? We want to hear about it: kdavidson@politico.com, aweaver@politico.com, or find us on Twitter @katedavidson or @aubreeeweaver.

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Driving the Day

Final fourth-quarter GDP data released at 8:30 a.m. … Richmond Fed’s Barkin speaks at 9:15 a.m. … SEC meeting on proposed rules for SPACs at 11:30 a.m. … Peterson Institute for International Economics virtual discussion on inflation and trade liberalization with former Treasury Secretary Larry Summers at 1 p.m. … House Financial Services hearing on oversight of America’s stock exchanges at 2 p.m.

TREASURY: MORE WESTERN SANCTIONS TO TARGET RUSSIA — Our Cristina Gallardo in London: “The U.S., EU and other allies plan further sanctions against Russian supply chains and economic sectors that play a key role in the war in Ukraine, U.S. Deputy Treasury Secretary Wally Adeyemo said. Speaking in London on Tuesday at the start of a European trip to consult allies on sanctions against Russia, Adeyemo said the aim was to undermine ‘the Kremlin’s ability to operate its war machine.’”

SENATE ADVANCES FED NOMINEE ON PARTY-LINE VOTE — Our Victoria Guida: “The Senate advanced Lisa Cook’s nomination to the Federal Reserve in a 50-49, party-line vote, putting her one step closer to confirmation to become the first Black woman to serve on the central bank's board. The vote allows her nomination to move beyond the Banking Committee, a procedural step that was required because she received an evenly split vote at the panel.”

FLORIDA PAUSES NEW INVESTMENTS IN CHINA — Our Gary Fineout: “Florida’s nearly $200 billion pension plan has halted new investments in China but will not attempt to offload any assets now held in Russian-based companies, despite a push by Democrats like Agriculture Commissioner Nikki Fried. Florida holds roughly $5.5 billion worth of assets in China, or about 2.8 percent, according to figures provided by the State Board of Administration.”

SMALL BUSINESS INDEX HITS PANDEMIC-ERA HIGH — Small business owners are feeling more optimistic about the health of their businesses than they have since the start of the pandemic, according to new research from the U.S. Chamber of Commerce and MetLife. The groups’ Small Business Index score ticked up to 64.1 in the first quarter. That’s a more than 60 percent increase from the pandemic-low score of 39.5 in the second quarter of 2020, but still below the 71.7 score in early 2020.

Of the surveyed business owners, approximately three in five say their business is in good health. A majority have taken steps to improve employee retention, including increasing schedule flexibility and wages, and providing employees with more opportunities for growth. One-third of small business owners rank inflation as their biggest challenge, up from 23 percent last quarter.

 

SUBSCRIBE TO NATIONAL SECURITY DAILY : Keep up with the latest critical developments from Ukraine and across Europe in our daily newsletter, National Security Daily. The Russian invasion of Ukraine could disrupt the established world order and result in a refugee crisis, increased cyberattacks, rising energy costs and additional disruption to global supply chains. Go inside the top national security and foreign-policymaking shops for insight on the global threats faced by the U.S. and its allies and what actions world leaders are taking to address them. Subscribe today.

 
 
Inflation Watch

AMERICANS, ESPECIALLY REPUBLICANS, ARE GETTING MORE WORRIED ABOUT INFLATION — NYT’s Jeanna Smialek: “Americans are more worried about inflation than at any point since 1985, and that concern is quickly escalating, according to a new poll, a potential problem for Democrats and the White House ahead of the midterm elections in November.

“A Gallup poll released Tuesday showed that rising prices were the No. 1 economic concern for Americans, with 17 percent calling inflation the ‘nation’s most important problem.’ Inflation stress divided slightly among income groups — 63 percent of adults earning $40,000 or less were very concerned, compared with 58 percent of those earning $100,000 or more — and starkly along political lines. About 79 percent of Republicans were seriously worried about inflation, versus 35 percent of Democrats.”

The latest Forbes Advisor-Ipsos Consumer Confidence Weekly Tracker, also found Americans expect inflation, mortgage rates and monthly bills will continue rising over the next year. Overall consumer confidence is up one percentage point from two weeks ago, clocking in at 53.5 — but still approximately 0.3 points below the pandemic average and 6.6 points below the pre-pandemic levels of early March 2020.

FED’S HARKER WORRIED ABOUT HIGH INFLATION — WSJ’s Michael S. Derby: “Federal Reserve Bank of Philadelphia President Patrick Harker said Tuesday unacceptable levels of inflation call for an aggressive path of interest rate rises to remedy surging price pressures. ‘Inflation is running far too high, and I am acutely concerned about this,’ Mr. Harker said in a speech in New York.”

 

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Crypto

A LESS-THAN-FANTASTIC VOYAGE — Our Sam Sutton writes: New Jersey’s Bureau of Securities has ordered the crypto trading platform Voyager Digital to stop offering yield-generating accounts through its so-called “Earn Program,” arguing that the products are unregistered securities. “Today’s action says loud and clear that the cryptocurrency securities market is not the Wild West, and investor-protection laws absolutely apply,” said the state’s acting Attorney General Matt Platkin in a statement.

Voyager’s response: "We firmly believe that our Voyager rewards program complies with the letter and spirit of the laws. We are in the very early stages of crypto regulation and working with state and federal regulators on the cryptocurrency industry.”

This isn’t the first time the Garden State has gone after digital asset companies that pool their customers’ crypto assets for loans and other investments. New Jersey hit BlockFi, which recently settled claims brought by the SEC and 32 states that it was operating an illegal lending business, with a similar order last year. The Celsius Network was directed to stop offering unregistered yield-generating accounts in September.

The SEC was reportedly looking into Celsius and Voyager’s products earlier this year — prior to the announcement on BlockFi. It’s also worth noting that Platkin served as New Jersey Gov. Phil Murphy’s chief counsel when current SEC Director of Enforcement Gurbir Grewal was the state’s top cop from 2018 to 2021.

MAJOR HACK — Also from Sam: In one of the largest digital heists in history, hackers stole roughly $600 million in cryptocurrency from a blockchain network linked to Sky Mavis, the creator of the popular online game Axie Infinity, and an associated decentralized autonomous organization (DAO). The hack targeted what’s known as a “bridge” protocol that allows users to transfer their crypto across different blockchains. Axie Infinity allows players to purchase non-fungible tokens representing different monsters that battle for crypto rewards.

The cyberattack occurred on March 23 but wasn’t uncovered until Tuesday, according to a blog post published by Ronin — the blockchain network that supports Axie Infinity’s gameplay. "We are working with law enforcement officials, forensic cryptographers, and our investors to make sure all funds are recovered or reimbursed,” the network wrote in a blog post. Remarkably, despite going almost a full week before being discovered, whoever perpetrated the heist is still holding most of the the stolen crypto in a single digital wallet.

 

STEP INSIDE THE WEST WING: What's really happening in West Wing offices? Find out who's up, who's down, and who really has the president’s ear in our West Wing Playbook newsletter, the insider's guide to the Biden White House and Cabinet. For buzzy nuggets and details that you won't find anywhere else, subscribe today.

 
 
Jobs Report

JR Kane is now government and civic relations program manager for the Federal Reserve Bank of San Francisco, focusing on federal engagement. He most recently was a legislative assistant for Sen. John Barrasso (R-Wyo.) and is an EPW Committee alum. (h/t Playbook)

Fly Around

Mortgage companies have a not-so-secret weapon as they deal with rising interest rates and decreasing volumes : Mortgage-servicing rights. — WSJ’s Telis Demos

Analysts and investors of major Wall Street banks are eagerly anticipating any insight from executives on the outlook for consumer spending and borrowing, a key source of revenue, when first-quarter earnings are unveiled next month. — Reuters’ Elizabeth Dilts Marshall

Wall Street and individual investors are once again dashing in and out of so-called meme stocks as the appetite for riskier assets revives and volatility grips the group. — Bloomberg’s Bailey Lipschultz

A message from Sallie Mae®:

What makes Sallie Mae different from other private student lenders and federal student lending? We help students search for scholarships and provide free resources like college savings calculators and comparison tools. We help students make informed decisions by providing all loan and repayment choices to them before they commit. And last year, less than 2% of our loans defaulted. These are the differences between lending and responsible private student lending. And these are the reasons why Sallie Mae makes sense for students and parents.

 
 

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