It’s all our fault. So sorry.
After colleague Lisa Beilfuss warned us this past weekend the markets are overlooking the threat posed by the Delta variant of the Covid-19 virus, the Dow Jones Industrial Average Monday suffered its biggest decline of 2021.
At the same time, the Treasury market had its best day since early spring as long-term yields (which move inversely to bond prices) plunged 12 basis points (or hundredths of a percentage point), a huge move. Arguably even more importantly, the slope of the yield curve (the difference between short- and long-term interest rates) flattened sharply, a reliable portent of slower economic growth.
Those moves were underlined by sharp slides in commodity prices, especially crude oil futures, which plunged 8% Monday. But oil’s drop was basically a catch-up move to the decline in copper. Both economically important commodities are down roughly 12% in the past two months.
Added to these signs of weakening economic momentum was the Russell 2000 index of smaller-capitalization stocks and the Dow Transports entering a so-called correction, ending over 10% from their recent highs.
At the same time, risk aversion rose in the options market as the Cboe Volatility Index (VIX) jumped to 24.46. During June, the stock market’s so-called fear gauge had been lulled into the mid-teens until being shaken out of its previous complacency.
But it’s been the bond market, whose refusal to follow the consensus call of higher yields, that has been sounding the alarm about the economy downshifting after its burst of growth following the economy’s reopening and the optimism from the initial availability of vaccines. Now that the pace of vaccinations has stalled, the rise in Covid-19 cases is taking its toll on the market along with the public health.
Just as some have insisted upon denying science, some market watchers have denied the message of the bond market, most notably the flattening of the long end of the yield curve from the fall in the more distant yields. A few have outright declared their forecasts to be right and that the bond market was wrong.
Others have pointed to the $120 billion of monthly securities purchases by the Federal Reserve as the factor lowering yields, even though that buying didn’t prevent the sharp rise in the benchmark 10-year Treasury from under 1% at the end of 2020 to nearly 1.75% at the end of the first quarter.
More to the point, the spread between two- and 10-year notes has fallen to 97 basis points Monday from 152 basis points two months earlier. Over the same span, the spread between the three-month T-bill and the 10-year note similarly has contracted, to 114 basis points from 167 basis points. Those contractions correspond with the decline in economically sensitive crude oil and copper from their peaks.
Indeed, just when academic economists, including those at the Fed, declare the yield curve’s usefulness as a predictor of the economy dead, “we see the curve slope again come back to bite the academics in the #$!,” writes Tom Tzitzouris of Strategas Securities.
But there’s more than circumstantial evidence from the markets that suggests something awry economically.
Carl B. Weinberg, chief economist of High Frequency Economics, writes in his weekly client note that global industrial production is stalling again after its V-shaped recovery from the pandemic plunge last year.
Moreover, he adds it appears industrial output is resuming the downtrend that began in 2018, “virtually unbroken by the Covid disruptions.” The dearth of bank lending since the Great Financial Crisis of 2008 is responsible for this stagnation.
Indeed, Weinberg thinks this period since then will be seen as analogous to the 1930s.
“People tend to forget the Great Depression was actually a 10-year event spanning three cycles of financial distress and economic contraction. In the United States, it was worsened mid-recovery by the appearance of the Dust Bowl, a Covid-like exogenous shock that disrupted economic activity for large swathes of the country.”
The 1930s also saw huge bull markets that punctuated the period. What’s that old saying about history not repeating but rhyming?
Write to Randall W. Forsyth at [email protected]
