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Ready For A Retracement As 10-2 Spread Inverts



Chief Market Analyst

Based on the trading action in the futures market, there is no mistaking that the cash market is going to start today’s session on a decidedly lower note. Currently, the S&P futures are down 41 points and are trading 1.2% below fair value. The indications aren’t any better for the other indices.

The Nasdaq 100 futures are down 120 points and are trading 1.4% below fair value, while the Dow Jones Industrial Average futures are down 389 points and are trading 1.3% below fair value.

There are myriad factors driving the negative disposition, yet they all tie back to underlying growth concerns.

  • The spread between the 10-yr Treasury note yield and the 2-yr note yield briefly inverted for the first time since 2007.
  • China reported the slowest pace of industrial production growth (+4.8% yr/yr in July) since 2002 and posted its 13th consecutive decline in passenger auto sales in July.
  • Germany registered a 0.1% qtr/qtr decline in Q2 GDP.
  • Retailer Macy’s (M) came up well shy of second quarter EPS estimates, spoke of rising inventory levels, and lowered its FY20 EPS guidance range before accounting for the fourth tranche of tariffs on goods from China.

The 10-2 inversion has been a central topic of conversation this morning in the business media, which is pointing out that it is regarded as a recession indicator.

The latter is a fair characterization. In April 2018, we published an article in The Big Picture column that examined the five recession periods since 1980. In every instance, those five recessions were preceded by an inversion in the 10-2 spread.

The salient point today is that the time between the first inversion and the start of the eventual recession averaged just over 18 months, with a range that spanned from ten months to two years. The stock market, however, is a forward-looking entity, so it will start to discount the specter of a recession ahead of time.

The strong response this morning, though, is perhaps a little premature as a full-fledged recession trade given the typical time lapse between the first inversion in the 10-2 spread and when each recession since 1980 has started.

Nevertheless, because of the 10-2 inversion headline, there is likely an algorithmic trading influence that is weighing disproportionately on the futures market. Hence, there has been a quick retracement of yesterday’s tariff-relief rally.

The growth concerns are legitimate, however, and they revolve around the potential contagion effect of tariff actions and weaker growth abroad being imported to the U.S.

Separately, the Import and Export Price Index for July didn’t help the growth narrative.

Import prices rose 0.2% m/m, but declined 0.1% excluding fuel. On a yr/yr basis, all import prices were down 1.8%, versus up 4.8% for the 12 months ending in July 2018, while nonfuel import prices declined 1.3% versus a 1.4% increase for the 12 months ending in July 2018.

The key takeaway from the report is that it doesn’t show any inflation, which stands in contrast to the Consumer Price Index for July. Accordingly, it will only serve to confuse the market’s perspective on the Fed’s read of inflation trends.

Originally Posted on August 14, 2019 – Ready For A Retracement As 10-2 Spread Inverts

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