LEI Close to Signaling Coming Recession:

  • The somewhat bullish take on the July FOMC minutes from Wednesday was reversed yesterday when a couple Fed officials reiterated the need for continued aggressive rate hiking. That has put pressure on Treasuries this morning with the 10yr note flirting with 3.0%.


  • St. Louis Fed President James Bullard continued in his role as lead hawk on the Fed with a call for a 75bps hike next month and expressed the desire to get to 4% by year-end. Kansas City Fed President Esther George was more moderate in her rate-hiking expectations near-term, but she did emphasize the need to raise rates until inflation eases back to its 2% target.


  • In that regard, despite the cooler July CPI report, the latest PPI readings from Germany remind us yet again that inflation is a global problem and one that is not going away soon. The July report missed to the high side by five full percentage points rising 37.2% YoY after a 32.7% YoY rate in June. That’s likely to catch the eye of Fed officials here and add emphasis to their hawkish inflation-fighting rhetoric.


  • Speaking of inflation-fighting rhetoric, investors will be looking ahead to next Friday’s Jackson Hole Central Bank Symposium keynote speech by Fed Chair Powell. They will be looking for clues to not only the size of the rate hike in September but the future pace and terminal rate expectation.


  • We think the September rate hike of 50 or 75bps will be decided by the upcoming August CPI and employment reports that will drop before the September 27 meeting. Thus,  we believe Powell won’t be shedding light on that outcome next Friday.


  • However, we do expect he will offer up some guidance on the pace beyond September as well as some expectations for the terminal rate. The minutes were less hawkish than expected, and expressed some concern about over-tightening, so it will be informative to see if Powell carries that somewhat cautious tone at Jackson Hole, or continues with the inflation-must-be-beat-at-all cost rhetoric.


  • Thus, we see continued volatility possible on the short end of the curve as investors gain additional insight on the Fed’s thinking regarding the terminal rate and when rate cuts might be in the offing. Remember too that the September FOMC meeting will bring with it a new set of dot plots and economic projections so the volatility will likely continue through September.


  • The above dances around the question of whether the Fed can negotiate a soft landing in bringing inflation down without tripping the economy into a recession. One of the indicators we have kept on hand for years in tracking this is the YoY Leading Economic Indicators. It’s a compilation of ten indicators that tend to lead the economy like building permits, jobless claims, average weekly hours, etc.. When it dips below zero, it signals a coming recession. The latest July read came in at -0.4% MoM and 0.0% YoY, so definitely heading into recession signaling territory, but not quite there yet. The graph below tracks the relationship between LEI and recessions (red bands) going back to the 1970’s and you can see the pretty good track record it has established.

Source: Bloomberg


Agency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
0.25 3.29 3.35 3.34 3.38 3.50 3.97
0.50 3.27 3.32 3.28 3.27 3.36 3.85
1.00 3.27 3.29 3.25 3.22 3.27 3.73
2.00 3.28 3.19 3.14 3.15 NA
3.00 3.10 3.09 NA
4.00 3.04 NA
5.00 3.01 NA
10.00 NA

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Published: 08/19/22 Author: Thomas R. Fitzgerald