Following Wednesday’s nosedive after the Fed announcement, the Dow, S&P 500 and Nasdaq have all rallied. The S&P 500 has risen over 8% since the banking crisis’ low in March, fueling enthusiasm among momentum traders.

“It’s official,” mimics a headline on CNN business, “We’re in a bull market,” with some fuzzy math showing the S&P has increased 20% since October.

Well, it’s Friday. So why don’t we take that premise for a spin?

Many an analyst, even within our own firm, have proclaimed the Fed has accomplished its mission. They’ve achieved the chimera known to economists and financial newsletter editors alike as “immaculate disinflation” – full employment, steady prices, a “soft landing” and no recession.

So, why the chatter about further rate hikes in July and later this year? Mostly because the Fed hasn’t hit its magic 2% inflation rate yet. Would another rate hike push the economy over the dark line of recession?

“We’ll just have to see,” JPow, as the Fed chair is known in certain circles, said in the post announcement press conference on Wednesday.

Indeed.

Before we get ahead of ourselves too much, there’s still the small matter of the “inverted yield curve.”

The yield curve graphically represents yields on bonds like U.S. Treasuries. Typically, the yield slopes up. Inverted yield curves are rare.

“A yield curve inverts,” Daniel Liberto informs us in a March 14 post on Investopedia, “when long-term interest rates drop below short-term rates, indicating that investors are moving money away from short-term bonds and into long-term ones. This suggests that the market as a whole is becoming more pessimistic about the economic prospects for the near future.”

You’ll recall bond yields drop as they become more popular and pricey. Yields go up when the bond issuer needs to raise capital. The Treasury department needs a lot of capital as they roll over the U.S. Debt. To raise that capital they have to pay higher interest rates.

In an inverted yield climate long term bonds have lower yields because traders are betting the Fed is going to have to lower rates to goose the economy once their battle against inflation is officially over.

A quick look at the chart above shows inverted yield curves and the onset of a recession are fairly consistent. Every time the blue line drops below the red one, the yield curve is inverted. The gray bands show recession in the economy.

In 1980, 1983, 1987, 1999, 2006, briefly before the pandemic in 2018. Everyone of these inversions was followed by a recession.

Today, the market reveals an inverted curve matched only by the early ‘80s before the worst recession the country has seen in 41 years.

Campbell Harvey, a finance professor at Duke, was among the first to observe the correlation between an inverted yield curve and an impending recession back in the ‘80s.

On Tuesday, prior to the Fed’s pause, Prof. Harvey was, er, ranting on Fox Business News that he couldn’t comprehend the FOMC’s line of reasoning.

By Harvey’s reasoning, using the employment numbers to determine policy, as the Fed does, is not sound. Employment numbers are a “lagging” indicator, meaning it takes some time before employment reflects the rate hikes’ impact on employment.

In Wednesday’s Missive, we took note that equilibrium with respect to price stability and employment is hard to achieve. The Fed has their model. But as our friend Jim Rickards likes to say, they just have the wrong model. Data is always lagging. Should the Fed raise rates more times this year, it’s likely they’ll overshoot.

Professor Harvey expects the Fed has already baked in a “hard landing” to the economy.

Of course, the economy and the market are not one and the same. The stock market rallied through seven bull market between the 1929 crash and the end of World War II – a period we now call The Great Depression.

Perhaps, we are in a bull market. But it’s a bull built on emotional enthusiasm, not necessarily a reflection of earnings or a strong economy.

So it goes,

Addison Wiggin,
The Wiggin Sessions

P.S. On January 3rd, JPow set the twittersphere alight by attending a Dead & Co. concert in Virginia with his son. Many an analyst tried to out pun each other with quips like… “The Grateful Fed”… “Fed Head, Dead Head”… “Estimated Prophet”… “Shakedown Street”.

My favorite was from Jim Bianco of Bianco Research. “The Grateful Dead?” Jim asked, “I would have thought he was a fan of Dire Straights… ‘Money for Nothing’.”

My wife, Jennifer, and I are going to see Dead & Co. in Noblesville, Indiana on June 27. Steal your face.