The Daily Prophet: Get Ready for More Yield-Curve Doomsday Talk

Connecting the dots in global markets.

You're not imaging things. February really was a month when nothing seemed to work in markets. Global stocks lost money for the first time since October 2016, the worldwide bond market was on track for its worst month since November 2016 and commodities fell the most since April. Sure, some assets did well: Finnish stocks, Chinese bonds and wheat. But from a tree-top level it's hard to see the everything-is-awesome environment that permeated markets in January coming back anytime soon.

Nowhere is that more apparent than the U.S. yield curve. Recall that everyone was up in arms late last year as the gap between two- and 10-year Treasury yields shrunk to its narrowest since 2007. That's important because a shrinking yield curve is typically associated with a slowing economy -- or even a recession if it inverts. Those concerns largely went away as the curve steepened from 50 basis points to 78 basis points earlier this month. But the curve has resumed narrowing and is back around 61 basis points as the worldwide economy suffers some missteps. Citigroup's global economic surprise index, which measures the data that exceed forecasts relative to those that miss, has tumbled to its lowest since September.

Granted, the Citigroup index doesn't mean the global economy is about to roll over, but it's understandable that investors would start to worry, especially when the chairman of the Federal Reserve sounds a bit too hawkish. "On one hand, inflation appears to have found solid footing and provides the Fed with ample cover to push forward with more rate hikes," the top-ranked interest-rate strategists at BMO Capital Markets wrote in a research note. "On the other hand, the growth profile shows some potentially troubling signs in the form of flagging consumption, disappointing durable goods, and a wider trade deficit" in the U.S., they added.

The MSCI All-Country World Index  declined 4.38 percent in February, breaking a string of 15 consecutive monthly advances despite strong gains in corporate earnings. The S&P 500 Index, the Stoxx Europe 600 and MSCI Emerging Markets Indexes were all lower as well. Besides some key economic data falling short of estimates, stocks have been rocked by rising volatility, which was something investors had become unaccustomed to last year as equities soared. “February finally cracked the volatility genie out of the bottle, and now the big question is: will he stay out for good?" Ryan Detrick, senior market strategist at LP research, wrote in a research note "The good news is that March kicks off two of the strongest months historically for equities, before we hit a period of seasonal weakness from May through October." Detrick notes that over the past 10 and 20 years, March has ranked as the second-best month on average for the S&P 500, with gains of 2.4 percent and 2.1 percent.

Despite rising yields at the end of 2017 and in January, the Bloomberg Barclays Global Aggregate Bond Index managed to generate positive returns. That ended in February, as the benchmark was down 0.99 percent through Tuesday and likely headed for a loss for the month. Along with signs of faster inflation, central bankers around the world are sounding like they are looking for any excuse to reverse years of extraordinarily accommodative monetary policy. In the first of his two days of testimony on the economy to Congress, Fed Chairman Jerome Powell said his “personal outlook for the economy has strengthened since December.” And instead of reiterating that the Fed's plan is to raise interest rates three times this year, he seemed to suggest that four rate hikes aren't out of the question. The worst-hit bonds this month were global corporate securities, which saw a decline of 1.82 percent through Tuesday. Chinese bonds managed to eke out a 0.49 percent gain, bringing its year-to-date return to an impressive 4.07 percent thanks, in part, to a stronger yuan.

If inflation were truly a concern, then it would be logical to expect to see big gains in commodities. Instead, the Bloomberg Commodities Index reversed two straight months of increases to post its biggest decline since March, falling 1.85 percent. Not even metals, whether gold or copper, managed to increase. Oil posted its first monthly decline in half a year on growing concerns about booming U.S. shale supply adding to a glut. Data Wednesday showed U.S. stockpiles of oil in tanks and terminals rose more than most analysts in a Bloomberg survey expected while gasoline reserves swelled at four times the predicted rate, according to Bloomberg News' Jessica Summers. Helping to feed the gain in crude stockpiles was yet another increase in domestic crude output to yet another record. Agriculture products were a bright spot in February, with the Bloomberg Agriculture Spot Index jumping 4.53 percent in its biggest monthly gain since June thanks to a surge in wheat, corn, soybean and cotton prices.

The foreign-exchange market may be sending the most troublesome signal of all. The Citi Parker Global Currency Index, which tracks the performance of 14 FX programs representing nine distinct investment styles, snapped four consecutive monthly losses to rally 0.37 percent in February. The star of month was the Japanese yen, which gained against all 31 major currencies tracked by Bloomberg. In addition, the Bloomberg Correlated-Weighted Index for the yen, which tracks the currency against nine developed-market peers, surged 4.76 percent this month to its highest level since June. That performance was better than the dollar, euro, pound or any of the other six currencies in the basket. But that's also concerning because the yen is known as a haven in times of crisis. That's because of Japan's status as the world’s largest creditor nation, with net external assets equivalent to more than 60 percent of gross domestic product, according to Peter Tasker, founding partner of Arcus Investment, a fund management firm specializing in Japan. Therefore, he says, fear or necessity is likely to provoke repatriation of capital.

Get ready for round two. Fed Chairman Powell makes his way back to Capitol Hill Thursday to conclude his semi-annual testimony to Congress. Typically, the second round of testimony is not very newsworthy, as the Fed chief usually just reiterates what was said before the House Financial Services Committee. But this one bears watching because Powell on Tuesday seen as a bit too hawkish when he seemed to suggest that four rate hikes this year isn't out of the question. That surprised markets, sending stocks and bonds lower, and the dollar soaring. Whether the comments were intentional or a rookie isn't the real issue going into Thursday. Instead, Powell faces a bit of a dilemma in that he can't really walk back the comments, because if he did he'd lose a bit of credibility. If he doubles down, though, markets could again be thrown into turmoil, which is not something he wants.

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