This is actually getting insane.

2023년 7월 4일

The chart above shows the 20-month EMA of the spread between the contract in front and the second contract in front for S&P 500 futures ES1!

It continues to explode, and this is a bad sign.



Since S&P 500 futures pricing includes the risk-free interest rate, the spread between the two contracts gives insight into the market's expectations about future interest rates.

To understand why the interest rate is used in the pricing of futures contracts, one has to understand futures contracts.

Futures contracts are agreements to buy or sell an asset at a predetermined price on a future date. The price of a futures contract is determined by a number of factors, including the current spot price of the underlying asset and the cost of carrying the asset to maturity.

The interest rate is used in the pricing of futures contracts because it represents the cost of carrying the asset to maturity for the contract seller. Since the contract seller could otherwise hold their money in a risk-free Treasury bond rather than in the S&P 500, the risk-free rate is therefore the opportunity cost to the seller, for which they must be compensated. The risk-free rate is therefore used because it represents the minimum return that must be earned in order for a rational market participant to sell an S&P 500 futures contract.

Since each S&P 500 futures contract must price in the interest rate, the spread between contracts that expire sequentially indicates the market's expectation of the future direction of the interest rate.

In this regard, the difference between sequential futures contracts guides the Federal Reserve's monetary policy, specifically the Fed Funds Rate, as shown in the chart below.



On the flip side, the yield curve inversion is steepening by the most in over 40 years.

Shown below is the difference between the 10-year U.S. Treasury and the 2-year U.S. Treasury.



The ratio of the 10-year U.S. Treasury bond to the 3-month U.S. Treasury bill is even worse, as shown in the chart below.


I adjusted the values by taking the square to account for periods when the 3-month Treasury bill yield went into the negative numbers

What does all of this mean? It means that a U.S. recession is for sure coming, and it's likely to be stagflationary in nature.

If you'd like to listen to my full thoughts, you can watch my video below.

When will the recession begin?

The below infographic, created by Fredric Parker, uses a probability distribution to infer that a U.S. recession is extremely likely to begin before the end of 2024.



The New York Federal Reserve places the chance of a U.S. recession beginning by May 2024 at nearly 71%. This is their highest predicted chance of a recession in over 40 years -- even higher than the Dotcom Bust and the Great Recession.



The amount of SPX volatility that's going to occur when the yield curve attempts normalization is probably going to be off-the-charts.

This is evidenced by the fact that S&P 500 volatility is sinking to cycle lows as bond volatility explodes at the highest rate of change on record.

To read more about this, you can view the post below that I co-authored with SquishTrade

With that said, July tends to be bullish and markets tend to be irrational. So perhaps the bull run will continue... for now.



Historically, the S&P 500 often rallies at the end of the tightening cycle, right as the market believes the rate hikes will come to an end, but before the market fully realizes the damage they've done.

Meanwhile, this is all occurring while the yearly Stochastic RSI for the SPX shows very strong downward momentum -- to a degree only seen during significant economic downturns.



Once the recession begins, it may last a long time or it may come in the form of multiple recessions. Central banks will fight the fires with more money, worsening inflation and causing whipsaws in monetary policy. Worst of all... During periods of severe economic downturn, major political instability and geopolitical conflicts often occur.

Central banks need scapegoats for their monetary policy failures.


Important Disclaimer
Nothing in this post should be considered financial advice. Trading and investing always involve risks and one should carefully review all such risks before making a trade or investment decision. Do not buy or sell any security based on anything in this post. Please consult with a financial advisor before making any financial decisions. This post is for educational purposes only.

2023년 7월 5일

노트

Here's a larger dataset that shows just how extreme the current yield curve inversion currently is:


10-year Treasury constant maturity rate vs. 1-year Treasury constant maturity rate