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Macro Monday 58 - Recession Warning Charts Worth Watching Macro Monday 58 Recession Charts Worth Watching If you follow me on Trading view, you can revisit these charts at any time and press play to get the up to date data and see if we have hit any recessionary trigger levels. They are very handy to have at a glance. CHART 1 10 - 2 year treasury yield spread vs U.S. Unemployment Rate Subject chart above Summary ▫️ The chart demonstrates how the inversion of the Yield Curve (a fall below 0 for the blue area) coincides with U.S. Unemployment Rate bottoming (green area) prior to recession onset (red areas). ▫️ The yellow box on the chart gives us timelines on how many months passed, historically, before a confirmed economic recession after the yield curves first definitive turn back up towards the 0% level (also see circled numbers showing connecting bottoming unemployment rate). ▫️ Using this approach, you can see that the average time frame prior to recession onset is 13 months (April 2024) and the max timeframe is 22 months (Jan 2025). ▫️ This is only a consideration based on historical data and does not guarantee a recession or a recession timeline however it significantly raises the probability of a recession, and the longer into the timeframe we are the higher that recession probability. ▫️ We typically we have a recession (red zones) either during or immediately after the yield curve moves back above the zero level. At present we are at -0.08 and fast approaching the zero level which is one of the most concerning data points of this week. ▫️ The unemployment rate moved from a low of 3.4 in April 2023 to 4.3 in July 2024. This is a significant increase and is typical prior to recession onset. Conclusion ▫️ If both the 10 - 2 year treasury yield spread and the U.S. Unemployment Rate continue in their upwards trajectory in coming weeks and months, this is a significant risk off signal and recession imminent warning. ▫️ The Sahm Rule triggered this week which has been one of the most accurate indicators of a recession starting. It is triggered when the three-month moving average of the U.S Unemployment Rate above rises by 0.50 percentage points or more, relative to its low over the previous 12 months. The Sahm rule triggering adds to recession concerns, however the designer of the rule has stated that I may not be accurate factoring in recent events like COVID-19 which has thrown unemployment and economic data to extremes. What is the 10-2 year Treasury yield spread? The 10-2 year Treasury yield spread represents the difference between the yield on 10-year U.S. Treasury bonds and 2-year U.S. Treasury bonds. It’s calculated by subtracting the 2-year yield from the 10-year yield. When this spread turns negative (inverts), it’s significant because it often precedes economic downturns. An inversion suggests that investors expect lower future interest rates, which can signal concerns about economic growth and potential recession. In essence, it’s a barometer of market sentiment and interest rate expectations What is the U.S. Unemployment Rate The unemployment rate is calculated by dividing the number of unemployed people by the total labor force in the U.S (which includes both employed and unemployed individuals). CHART 2 Interest Rate Historic Timelines and impact on S&P500 Summary ▫️ This chart aims to illustrate the relationship between the Federal Reserve’s Interest rate hike policy and the S&P500’s price movements. ▫️ This is obviously pertinent factoring in the expectations of a rate cut in Sept 2024. This chart which I shared in Sept 2023 may have accurately predicted this likely Sept 2023 interest rate cut but is this positive for the market? ▫️ Interest Rate increases have resulted in positive S&P500 price action ▫️ Interest rate pauses are the first cautionary signal of potential negative S&P500 price action however 2 out of 3 pauses have resulted in positive price action. The higher the rate the higher the chance of a market decline during the pause period. ▫️ Interest rate pauses have ranged from 6 to 16 months (avg. of 11 months). ▫️ Interest rate reductions have been the major, often advanced warning signal for significant and continued market decline (red circles on chart) ▫️ Interest rates can decrease for 2 to 6 months before the market eventually capitulates. ▫️ In 2020 rates decreased for 6 months as the market continued its ascent and in 2007 rates decreased for 2 months as the market continued its ascent. This tells us that rates can go down as prices go up but that it rarely lasts with any gains completely wiped out within months. Conclusion: ▫️ Rate cuts should signal significant concern as most are followed immediately by recession or followed by a recession within 2 to 6 months of the initial cut. This is high risk territory. ▫️ During the week I seen the 2 year treasury bill which matches closely the Federal Reserve interest rate cycle. The spread developing between the two suggests rate cuts are imminent. Remember point one above. The chart below: CHART 3 Relationship between 2 Year Bonds and Interest Rate ▫️ Very briefly, you can see the red areas where gaps formed when the Federal Reserve interest rate was lagging behind the 2 year treasury bonds declines. ▫️ Currently there is a large gap of 1.74% between the two data sets. The last time we had gaps like this were prior to the 2000 and 2007 recessions. Even prior to COVID-19 you can see the Federal reserve was playing catch up. What to watch for in coming weeks and months? ▫️ If both the 10 - 2 year treasury yield spread and the U.S. Unemployment Rate continue in their upwards trajectory in coming weeks and months, this is a significant risk off signal and recession imminent warning. ▫️ Since 1999 the Federal reserve interest pauses have averaged at 11 months. July 2024 is the 11th month. This suggests rate cuts are imminent. ▫️ The 2 year bond yield which provides a lead on interest rate direction is suggesting that rates are set to decline in the immediate future and that the Fed might lagging in their rate cuts. Furthermore, rate cuts are anticipated in Sept 2024 by market participant's. ▫️ Finally, rate cuts should signal significant concern as most are followed immediately by recession or followed by a recession within 2 to 6 months of the initial cut. Yet the market appears to be calling out for this. This is high risk territory. Combine this with a treasury yield curve rising above the 0 level and an increasing U.S. unemployment rate and things look increasingly concerning. We can keep any eye on these charts for a lead on what might happen next. I will be reviewing some other charts over coming days around jobless claims and ISM figures to see how positive and negative we are looking. PUKA
FRED:T10Y2Y
by PukaCharts
4
Potential opportunity from interest rate volatility - $IVOL Quadratic Interest Rate Volatility & Inflation Hedge ETF AMEX:IVOL Quadratic Interest Rate Volatility and Inflation Hedge ETF AMEX:IVOL is starting to look interesting. I wonder can it break above the 10 month smooth moving average this time? Do you think there is a chance of interest rate volatility and want to profit off it? Do you think there is a chance of widening spreads between 2-year Treasury bond yields and 10-year Treasury bond yields? If so this ETF might perform nicely in coming months. What is the IVOL ETF product? Its objective is to protect against inflation whilst providing additional returns from options contracts. IVOL was launched in May 2019 by Quadratic Capital Management under management of @nancy__davis, a prior Goldman Sachs trader who is also quiet the looker. IVOL is an intriguing way to benefit from higher interest rate volatility and widening spreads between 2-year Treasury bond yields and 10-year Treasury bond yields. The ETF should not be confused as an investment to protect against rising interest rates as that is not its objective, it reacts off interest rate volatility and widening 10Y/2Y spreads. IVOL’s inflation protection component is straightforward with 87% of its assets invested in the Schwab U.S. TIPS ETF $SCHP. IVOL earns interest on the inflation-protected bonds held by SCHP. IVOL also benefits from the principal increase in the Treasury Inflation-Protected Security (TIPS) based on the inflation rate. I might do another brief explainer on this product next if you like? The remaining 13% component is mainly options orientated and more complicated. In simple terms if interest rate volatility increases or if investors expect larger fluctuations in interest rates, then the value of the options held by IVOL increases. If interest rate volatility falls, then the options held by IVOL will fall in price. Its a very interesting product given the consistent movement in interest rates over recent months and the spread between the 2Y and 10Y being at an inflection point. I had to put together a chart for for the IVOL and it appears the RSI has a great history of picking tops and bottoms. It is an interesting and gradually growing ETF product that may be of use in the near term. I hope the explanation helps but more so, I hope that the chart will help anyone using the IVOL to avoid unnecessary risk. PUKA
AMEX:IVOLLong
by PukaCharts
How to position for yield curve un-inversions!It has been some time since we delved into the intricate world of interest rates and their prospective trajectories. With the yield curve experiencing significant movement in recent weeks, it's high time we reassess our stance. Following a staggering 500 basis points increase, we now find ourselves potentially nearer to the end of the rate hike cycle than ever before. The recent hawkish pause announced in the last meeting has left market participants on tenterhooks, pondering the future course of action in the ongoing battle against inflation. Given the downward trend in inflation and the possibility of at least one more rate hike, 'real' yields have ascended beyond the 0% level, as depicted in the chart above. Since the 2010s, real yields have consistently struggled to surpass the 1.2% level. However, the recent lower inflation prints place the 'real' yield at a new decade high of 1.25%. So, how does the yield curve inversion behave during periods of real yields? Interestingly, in three of the past four instances, the curve 'un-inverted' once real yields exceeded 0. Of greater significance is the yield curve's response after the Fed cuts rates. Since 1989, this has been a key signal of the yield curve un-inversion. Given this event's proximity and the current 2Y-10Y yield curve, we contemplate the optimal strategy to capitalize on this likely un-inversion. One approach is to examine all possible inversion combinations between the 2, 5, 10, and 30-year yields. All these combinations present an inverted curve, except for the 10Y-30Y segment. Upon dissecting the analysis to focus solely on 2-year inversions, we observe the following: The 2-year inversion is generally the steepest, with the 2Y-10Y ranking as the most inverted segment of the yield curve. All inversions anchored with the 2Y are at their all-time highs, plunging us into uncharted waters. In contrast, the 5-year and 10-year yields exhibit more subdued movements. Their inversions have yet to reach all-time highs, and the overall range of movement is relatively restrained. Therefore, to maximize returns on the un-inversion move, one could position to short either the most inverted section of the curve, the 2Y-10Y, or the 2Y-30Y, which typically experiences the largest movement upon un-inversion. Handily, CME has the Micro Treasury Yield Futures, quoted in yield terms, which allows us to express this view in a straightforward manner allaying the complications with DV01 calculation. By creating a short yield spread position, we are not merely speculating on the direction of individual yields but rather on the relative movement between them. Trading the yield spread instead of just an outright position in a single part of the curve also protects us from parallel shifts in the yield curve, especially in volatile times like these. This strategy takes advantage of the yield curve dynamics, particularly the inversion trend we've been observing. We create the short yield spread position by taking a short position in the Micro 2-Yr Yield Futures and a long position in the Micro 10-Yr Yield Futures or Micro 30-Yr Yield Futures to express the curve un-inversion view, with 1 basis point move equal to 10 USD. The charts above were generated using CME’s Real-Time data available on TradingView. Inspirante Trading Solutions is subscribed to both TradingView Premium and CME Real-time Market Data which allows us to identify trading set-ups in real-time and express our market opinions. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com Disclaimer: The contents in this Idea are intended for information purpose only and do not constitute investment recommendation or advice. Nor are they used to promote any specific products or services. They serve as an integral part of a case study to demonstrate fundamental concepts in risk management under given market scenarios. A full version of the disclaimer is available in our profile description. Reference: www.cmegroup.com www.cmegroup.com www.cmegroup.com
TVC:US02YShort
by inspirante
The yield curve has to un-invert eventually… right? (Part 2)This week, we thought it will be interesting to review the trade from last week given the reaction post-FOMC, as well as discuss an alternative way to set up this trade. Firstly, let’s review the post-FOMC/employment data reaction. - Nonfarm Payrolls surprised to the upside, as over half a million jobs were added way above the estimates of a sub 200K number. - Unemployment rate continues to fall further, reaching a 53-year low of 3.4% A clear re-pricing has occurred since last Friday’s better-than-expected jobs data and Wednesday’s Federal Reserve meeting. With markets now expecting 1 more rate hike in May, bringing the peak rate up from the 475 -500 bps range to the 500-525 bps range. Keeping this in mind, we go back to our analysis last week to understand this situation and historical precedence. While the time for a pause in rate hike seems to be pushed back, in the grand scheme of things, we think that this has only kept the window of opportunity for this trade open for longer and at a more attractive entry point now. Without repeating ourselves too much, we encourage readers to take a look at our idea last week which explores the historical correlation between the peaking of yield curve inversion and the pause in Fed rate hikes. Link to our last week’s idea: This week, let’s tap into a different instrument. Here, we aim to take a short position on the 2Y-10Y yield differential by creating a portfolio of Treasury futures to express this view. To do so, we would have to first select the 2 instruments, the 2-Yr Treasury futures is a straightforward choice for the short end. But for the 10-Yr leg, we have a choice of the '10-Yr Treasury Note Futures' vs the 'Ultra 10-Yr Treasury Note Futures'. Digging into the contract specification, the 'Ultra 10-Yr Treasury Note Futures' provide a better proxy for the true 10-year duration exposure as the delivery requirements are for Treasuries with maturities between 9year 5 months and 10 years. In comparison, the underlying of '10-Yr Treasury Note Futures' has a maturity between 6 year 6 months and 10 years. With contract selection out of the way, the next step is to calculate the Dollar Neutral spread. This requires us to identify the DV01 of the front and back legs of the spread and try to match them. This is to ensure that the entire position remains as close to dollar neutral as possible, so we can get a 'purer' exposure to the yield difference between the front and back legs, and parallel moves are negated. CME publishes articles on this topic to explain the setting up of a DV01 spread clearer than we can explain. You can find them attached in the reference section below. You can handily find the DV01 of the Cheapest To Deliver (CTD) securities on CME’s website. In this case, we are looking at the 2Yr and Ultra 10Yr Treasury Futures to set up the trade. With the DV01 of the 2Yr at 34.04 and the DV01 of the Ultra 10Yr at 96.26. The spread ratio can be calculated as 96.26/34.04 = 2.83. Rounding this to the nearest whole number, we would need 3 lots of2-Yr Treasury Future and 1 lot of Ultra 10-Yr Treasury Future, to keep the DV01 equal (neutral) for both legs of this portfolio. Given our view of the 2Yr-10Yr yield spread turning lower, we want to short the yield spread. Yield and prices move inversely, hence, to short the yield spread, we long the Treasury Futures spread as it is quoted in price. We can long 3 ZTH3 Futures (2Y Treasury Future) and short 1 TNH3 futures (Ultra 10Y Treasury Future) to complete 1 set of the spread. However, since the 2-Yr Treasury Futures has a notional value of 200,000 while the Ultra 10Y Treasury Futures a notional of $100,000, the price ratio will be 6:1 when the position/leg ratio in the spread trade is 3:1. As such the current level would provide us with an entry point of roughly 494 with a minimal move in Ultra 10yrs representing 15.625 USD and that in 2Y representing 7.8125 USD. While slightly more complex in setting up, this trade allows us another alternative to express the same view on the yield curve spread differential. Being able to execute the trade via different instruments allows you to pick the most liquid markets to trade or take advantage of mispricing in the markets. The charts above were generated using CME’s Real-Time data available on TradingView. Inspirante Trading Solutions is subscribed to both TradingView Premium and CME Real-time Market Data which allows us to identify trading set-ups in real-time and express our market opinions. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com Disclaimer: The contents in this Idea are intended for information purpose only and do not constitute investment recommendation or advice. Nor are they used to promote any specific products or services. They serve as an integral part of a case study to demonstrate fundamental concepts in risk management under given market scenarios. A full version of the disclaimer is available in our profile description. Reference www.cmegroup.com www.cmegroup.com www.cmegroup.com www.cmegroup.com
CBOT:ZT1!Long
by inspirante
6
The yield curve has to un-invert eventually… right?Those who have been reading our past 2 ideas will know we’ve been harping on and on about expected rate path and policy timelines. Why the recent obsession you ask? Because we think we’re on the cusp of major turning points. So, for the third time, let’s look at the market’s expected policy rate path. With FOMC coming up this week, we are expecting a 25bps hike followed by some commentary/guidance on the next cause of action. Based on CME’s Fedwatch tool, markets are expecting a last hike of 25bps in the March FOMC before a pause in the hiking cycle. Now keep that in mind. One interesting relationship we can try to observe is how the 2Yr-10Yr yield spread behaves in relation to where the Fed’s rate is. We note a few things here. Firstly, the ‘peak’ point of the 2Yr-10Yr spread seems to happen right around the point when rate hikes are paused. With the Fed likely to pause as soon as March, we seem to be on the same path, setting up for a potential decline in the spread. Secondly, the average of the past 3 inversions lasted for around 455 days, and if you count just the start of the inversion to the peak, we’re looking at an average of 215 Days. Based on historical averages, we are past the middle mark and have also likely peaked, with current inversion roughly 260 days deep. Looking at the shorter end of the yield curve, we can apply the same analysis on the 3M-10Yr yield spread. The ‘peak’ point of the 3M-10Yr yield spread is marked closer to the point when the Fed cuts, except in 2006, while the average number of days in inversion was 219 days and the average number of days to ‘peak’ inversion was 138 days. With the current inversion at 105 days for the 3M-10Yr Yield spread, we are likely halfway, but the peak is likely not yet in. (Although eerily close to when the Fed is likely to announce its last hike, March FOMC, 51 days away). Comparing the 2 yield curve spreads, we think a stronger case can be made for the 2Yr-10Yr spread having peaked and likely to un-invert soon. Handily, CME has the Micro Treasury Yield Futures, quoted in yield terms, which allows us to express this view in a straightforward manner allaying the complications with DV01 calculation. We create the short yield spread position by taking a short position in the Micro 2-Yr Yield Futures and a long position in the Micro 10-Yr Yield Futures, at an entry-level of 0.623, with 1 basis point move equal to 10 USD. The charts above were generated using CME’s Real-Time data available on TradingView. Inspirante Trading Solutions is subscribed to both TradingView Premium and CME Real-time Market Data which allows us to identify trading set-ups in real-time and express our market opinions. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com Disclaimer: The contents in this Idea are intended for information purpose only and do not constitute investment recommendation or advice. Nor are they used to promote any specific products or services. They serve as an integral part of a case study to demonstrate fundamental concepts in risk management under given market scenarios. A full version of the disclaimer is available in our profile description. Reference: www.cmegroup.com www.cmegroup.com
CBOT_MINI:2YY1!Short
by inspirante
9
When downside volatility becomes an advantage.It’s been a while since we looked at the Russell 2000. For the uninitiated, the Russell 2000 index is a small-cap stock market index that is made up of the smallest 2000 stocks in the Russell 3000 Index. The small-cap nature means a few things, volatility tends to be higher for one. And capturing this downside volatility using the Russell 2000 as compared with the S&P 500 has almost always proven more fruitful. When to take this trade you may ask? The recession bellwether indicator of the 2Y – 10Y yield spread is a simple place to start. With the benefit of hindsight, shorting each of the indexes at the peak ‘inversion’ points proves to be a decently successful strategy. Especially so using the Russell 2000. So the next question to ask is if we are near the peak point of inversion? To answer this, we have to circle back to research from last week, where we discussed the expected rate path for the Federal Reserve (Fed). In short, markets seem to be pricing in a Fed pause, followed by a pivot in the coming year. Looking back at the charts, this shift in stance (or pause) highlighted in the top chart generally marks the turning points for the 2y-10y yield curve inversion, highlighted in the bottom chart. Therefore, with markets expecting a pause as early as the first quarter, we suspect that the turning point for the yield curve inversion is just around the corner. On price action, the 1900 level proves to be of significant resistance, with multiple attempts to break through being rejected. As prices creep towards this resistance level once again, we think this might just provide another attractive opportunity for trading. Zooming out to a daily timeframe, the 0.382 Fibonacci levels marked by the previous high and low, also coincide close to the resistance levels on the shorter timeframe. The proven downside volatility, along with the coming turning point in the yield curve inversion, keeps us bearish on the Russell 2000. Additionally, the price action points to significant resistance overhead, around the 1900 level. Setting our stop at 2035 level (one Average True Range away & close to the next resistance level) and take the profit level at 1690, with each 1-point increment in the Russell 2000 futures contract equal to 50$. The charts above were generated using CME’s Real-Time data available on TradingView. Inspirante Trading Solutions is subscribed to both TradingView Premium and CME Real-time Market Data which allows us to identify trading set-ups in real-time and express our market opinions. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com Disclaimer: The contents in this Idea are intended for information purpose only and do not constitute investment recommendation or advice. Nor are they used to promote any specific products or services. They serve as an integral part of a case study to demonstrate fundamental concepts in risk management under given market scenarios. A full version of the disclaimer is available in our profile description.
CME_MINI:RTY1!Short
by inspirante
10