US 2-10 Yield Spread Versus Russell 3000 Index; Hook Pattern Forecasts Potential Recession

(this article originally appeared on The Keystone Speculator blog on 1/31/19)

by K E Stone

There is lots of talk about the potential yield curve inversion last year into this new year. The 2-3's and 2-5's have inverted but not the 2-10 which is shown in the chart above. The 2-10 spread did, however, get all the way down to 9 bips (0.09% difference between the 2-year and 10-year yields). Is that close enough for government work?

Television pundits are singing from the same hymn sheet saying that a recession will not occur until 2020 and many say 2021. On top of that, the Einstein's say the stock market will not sell off in any substantive way until a few months after the yield curve inversion occurs. As the above chart shows, they are correct in that a yield curve inversion occurs (the 2-10 spread crosses below zero as the 2-year yield moves above the 10-year yield) before a recession.

As a chart technician, patterns are important. One of the reasons traders prefer using technicals is that they see in a more visual and creative way than their analytical brothern that are better suited to study the minutia in the balance sheets (technical analysis versus fundamental analysis). What jumps out at you in the chart above is the red hook pattern.

It is correct to say that a yield curve inversion precedes a recession and stock market collapse, but you must decide if the red hook pattern is what better predicts a recession. The predictor of the recession is the action and pattern of the 2-10 spread where it bottoms and rises and not the idea that it must officially invert to zero. This concept makes sense since business conditions tighten in the rising rate environment starving off the economy.

The Federal Reserve and other global central bankers play a big role in this sick financial game. The Fed, ECB, BOJ and PBOC are starting the year with gun's blazing. China's central bank (People's Bank of China) cut the triple R's and Fed Chairman Powell is flapping his dovish wings. Former Fed Chair Yellen was Queen of the Doves that printed money and maintained ZIRP or near-zero interest rates to boost stocks and reward the wealthy class. Powell is now dubbed King of the Doves essentially taking rate hikes off the table going forward. The central bankers are one-trick ponies that only know how to print money and please their privileged-class masters.

As this message is typed, Treasury yields are; 2-year 2.49%, 5-year 2.47%, 10-year 2.666% and 10-year 3.02%. The 2-5 spread is inverted by -2 bips. The 2-10 spread is 18 basis points. The yield curve is steepening in relation to its flattening behavior down to 9 bips late last year.

Thus, do you believe the Wall Street line that a recession is at least a year or two away and a serious market downturn will not occur until months after that thus 2 to 3 years in the future? Are you drinking the Fed Kool-aid, ECB champagne, BOJ sake and PBOC rice wine, with a lampshade on your head, chasing the stock market rally buying stocks at the ask? Or, are you wondering if the red hook indicates that the recession is far closer than anyone expects and set to begin in a few weeks or a few short months? What camp are you sitting in?

The global central banker game continues as long as investors and traders have confidence in the easy money policies. Yesterday's big US stock market rally proves that traders still believe in the Fed and the dovish talk creates the upside joy. When confidence in the central bankers is lost, all is lost. Powell has performed a sharp turnaround in a short couple-months from hawk to dove. One would think confidence would be lost in such leadership. The Fed is steering the ship but they have no idea where they are going.

A short time ago, across the wires, the BOJ pledges to maintain its easy money policies going forward. Of course they do. The central bankers are sick. This information is for educational and entertainment purposes only. Do not invest based on anything you read or view here. Consult your financial advisor before making any investment decision.