When last we checked in on SocGen’s Albert Edwards, he was regaling readers with a story about the time he almost perished in a road rage incident he says “was caused by a car driver with whom I had been having an altercation, winding down his window and trying to push me off the bike as I drove past at high speed.”
Somehow, he managed to draw a parallel between that episode and the U.S.-China trade spat. The Chinese economy, Albert said, is like a highly unbalanced motorcycle or ship, and Trump’s tariffs “amount to a similar unbalancing shove as China drives past the US to become the largest economy in the world.”
Speaking of that “highly unbalanced” ship, CPI and PPI both missed overnight, underscoring concerns about the Chinese economy and stoking deflation worries anew.
On Thursday, Albert is back and he wants to talk about the Fed’s dovish relent, which gathered steam last Friday (when Jerome Powell suddenly figured out how to communicate with markets under the watchful eyes of Yellen and Bernanke who were sitting right across from him as he successfully jawboned markets higher) and kicked into high gear on Wednesday when a procession of dovish rhetoric from multiple Fed speakers tanked the dollar and set the stage for the December Fed minutes which suggested that last month’s Powell presser did not necessarily reflect the actual discussions that went on during the policy meeting.
Edwards also wants to discuss the blowout December payrolls print that hit just hours ahead of Powell’s Friday remarks.
Long story short, Edwards isn’t buying the idea that a bear market in stocks can be averted and to support his assertion, he’s reiterating some of the points made recently by Nomura’s Charlie McElligott about steepening presaging a downturn.
“A combination of better than expected US employment data and what I can only describe as abject capitulation from Fed Chair Powell has led to a relief rally in equities from deeply oversold levels”, Edwards writes, before asking: “What next?” Well, here’s what’s next, according to Albert:
If we are indeed nearing the point where the Fed stops tightening (both QT and Fed Funds), should this offer investors confidence that an equity bear market can be avoided? No! Traditionally the yield curve steepens as the Fed eases immediately prior to a recession. And market confidence that the strong December payroll data means a recession cannot be imminent is equally misplaced…payrolls often accelerate just ahead of a recession.
We could probably just leave it at that because as usual, Albert manages to capture the gist of his entire note in the first bullet point of the cover page, but we’ll grab a few additional passages for good measure.
On the jobs report, Edwards simply says that accelerating payroll data is not “untypical just ahead of recessions”. As far as the curve goes, the first thing to note is that the 2s10s and 5s30s are steeper by ~8 and ~16bps, respectively, from the December 20 tights, setting the stage for the following from Albert:
There was a level of equity market weakness that was always going to generate a re-introduction of the fabled Fed put. But after Fed Chair Powells post FOMC reiteration that QT was on autopilot, I certainly thought it would take a lot more than a 20% decline in equity markets for Powell to re-embrace the Fed put like a long-lost friend. The subsequent rapid unravelling of expectations of Fed tightening has steepened the yield curve. Yet this curve steepening, after a period of pronounced flattening, is a good indication of imminent recession despite continued strength in the labour market (see chart below: you cannot observe the recent steepening of the curve on the dotted line below as it is a monthly plot).
Albert then cites a series of technical analysts and as regular readers know, we’re no fans of technical analysis. But Edwards is extremely adept at defusing potential consternation from readers (there’s a reason why he’s still around and still winning awards). After citing SocGen’s head of Technical Analysis who believes that the nascent rebound in stocks and 10-year yields will likely prove fleeting, Edwards offers the following in support of his allusions to the technicians:
Many investors have a big downer on technical analysis. As a fundamental analyst, many of my readers become apoplectic with rage (or just plain disappointed) when they see I have put a technical chart in my weeklies. My old colleague David Owen (now at Jefferies) always reminds me of the story of when in 1991, our then Chief Economist Blu Putnam discovered me on the Datastream machine looking at technical analysis, and I fell drastically in his estimation albeit probably not from a very high level. But let me repeat: I believe that if an equity bear market is unfolding, it will be the technical analysts and not the macro-analysts that will inform us, and a collapse in the markets will precede a recession, just as it did in 2007.
Again: Albert knows how to endear readers and keep them coming back for more even when he’s predicting the apocalypse or, perhaps worse, citing technical analysis.
Getting back to the idea that investors should fear the subsequent steepening, not the flattening/inversion, we wanted to make a few quick points. As noted above, Nomura’s Charlie McElligott has recently expounded on this topic and the posts we’ve run highlighting excerpts from Charlie’s notes on the subject generate a lot of interest. Here, as a reminder, are the two visuals that McElligott uses to illustrate the point:
In the interest of providing a counterpoint, we wanted to bring in some commentary from a strategist we were chatting with a few days ago about this.
The following is a paraphrased/truncated version of that strategist’s take which we imagine some readers will find instructive in the course of thinking about the curve, downturns and equities. These comments are presented without further editorializing from us.
There’s an issue of causality when you say inversion ’causes’ recession or recession ’causes’ stock market declines. This is not always correct and can be misleading. 1999 was an internet bubble burst [and] not much to do with Fed hikes; it just ran its course and died (of ‘natural’ causes). During that time, productivity growth was >3% and the economy was calibrated accordingly. When the bubble burst there was recession and Fed had to cut rates.
2004-7 was different. The securitization industry prevented transmission of rate hikes to the consumer. Although Fed hiked 400bp (they had to because inflation was rising), consumers were borrowing low through arms, so the Fed had to overshoot and the curve inverted. But that by itself didn’t cause the recession. The recession was triggered when arms started resetting and subprime borrowers felt all 400bp at once and started the chain reaction of defaults. This recession was a direct consequence of the Fed, but not Fed hikes as much as Greenspan‘s incompetence. The curve steepened in anticipation of rate cuts and equities declined, because it was the end of the housing bubble. And again, the economy was calibrated for it – productivity growth was >3% etc. But one cannot say that the steepener was an indicator of imminent equities decline.