The probability of an economic slowdown is rising, which leads to lower interest rates and a deceleration in inflation. Interest rates and inflation breakevens have been declining since the recent rate hikes. The inversion in the Eurodollar futures curve has deepened over the last few weeks. Commodities have started to decelerate from their prior peaks and the U.S. Dollar Index is at its highest level in 20 years.
Government bond yields in the United States, United Kingdom, Germany, France, and elsewhere have moved lower since the round of June rate hikes. The U.S. 10-Year Treasury yield was 3.33% on June 15th, which was the day of the second rate hike from the Federal Reserve. It now sits 45 basis points lower at 2.88%. 10-Year notes are also down 5 basis points from the first rate hike on May 4th.
The United Kingdom 10-Year yield was at 2.51% when the Bank of England hiked rates on June 16th. It is now 45 basis points lower at 2.06% and just 9 basis points higher than their first rate hike on May 5th.
A similar dynamic is playing out in Germany with its 10-Year peaking on June 21st and now down 49 basis points. The French 10-Year has also moved lower since June 21st, down 57 basis points to 1.76.
Inflation breakevens are another set of market-based measures for inflation expectations that are headed in the wrong direction. Since March 25th, the U.S. 5-Year breakeven inflation rate has dropped 99 basis points to 2.60%. The U.S. 10-Year breakeven inflation rate has come down 68 basis points from its prior peak on April 21st to 2.34%.
The Eurodollar futures curve is a market-based measure of future short-term interest rates. In a positive environment the curve slopes upward, but it is currently inverted. Over the last few months, the curve has inverted deeper and moved closer to present day. As of last Friday, the inversion begins at the December 2022 contract. This suggests that investors are starting to position for rate cuts between December and March 2023.
Outside of rates moving lower, we are also seeing most commodities start to decelerate. WTI Crude Oil, Natural Gas, Lumber, Copper, Aluminum, Steel, Wheat, and others are below their prior peaks.
In another sign of potential weakness in global activity, the U.S. Dollar Index is at its highest level in 20 years. This is typically a sign of a risk-off environment as the outlook for growth is weaker. Historically, a stronger U.S. Dollar is a hinderance on global activity as access to the currency becomes more expensive. On a three-month and one-month basis, the U.S. Dollar is outperforming all developed market currency pairs and most emerging market pairs. It is also at its highest level versus the Japanese Yen since 1998 – the tail end of the Asian Financial Crisis.
Since the June rate hikes, the market has shifted to price in a slowdown of growth and inflation. From interest rates to commodities and the U.S. Dollar, these market signals moving in tandem suggest we are moving into an environment that does not warrant more rate hikes.
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Senior Vice President, Investment Strategy
Boyd Watterson Asset Management, LLC