As warning signs for the economy mount, investors are cheering for more bad news. That's because they expect economic weakness will force the Federal Reserve to stop raising interest rates and eventually re-embrace loose monetary policy. One reliable indicator over the years of an upcoming recession is an inverted yield curve. An inversion occurs when short-term interest rates rise above long-term rates. Typically, a 3-month Treasury bill or 2-year note will yield less than a 10-year note or 30-year bond. Shorter-duration debt instruments entail less risk and therefore deliver less reward under normal circumstances. But over the past four months, short-term IOUs have begun to yield more than longer-term paper. This week, the yield on the 10-year Treasury fell to 3.7%, while the 2-year rose to 4.4%. That represents the biggest yield curve inversion in decades. And as institutional futures trader and broker Jim Iuorio notes, the current inversion implies strongly that a recession is coming. Jim Iuorio: A normal sloped yield curve has longer term bonds paying higher interest rate than shorter term. The higher rate is a reward for being willing to lock up your money for longer periods of time. Economists believe that an inversion of yields is a warning sign for coming recession, as investment money seeks the safety of longer-term bonds, helping to keep those yields from rising while at the same time, in this instance, that the Federal Reserve is forcing up short-end rates through hikes. The yield curve has inverted before each recession dating back to 1955, with the recession starting between six and 24 months after the inversion. Ultimately, the curve's current lesson could be that the market believes that the Fed's aggressive hikes to fight inflation could lead to both recession and the need to quickly lower rates at some time in the future. The U.S. economy technically dipped into a recession in the second quarter when GDP came in negative for a second consecutive quarter. At that time, however, the jobs market remained strong and the housing sector had only just begun to show signs of softening. The double dip downturn that many economists see coming in 2023 could result in millions of job losses and a major retrenchment in home prices. The stock market will obviously be vulnerable as well. As for precious metals markets, they have often shown relative strength during previous recessions. They have also tended to get a boost when an inverted yield curve starts to normalize. That would be expected to occur when the Fed begins to cut its benchmark short-term rate. For now, though, central bankers are vowing to keep hiking. On Thursday, James Bullard, president of the Federal Reserve Bank of St. Louis, said the Fed funds rate will likely rise higher than previously expected. He said the current rate isn’t “sufficiently restrictive” in light of inflation that remains stubbornly high. According to Bullard, rates may have to move up to as high as 7%. Most investors don’t seem to be buying Bullard’s hawkish posturing. Financial markets are pricing in a 50-basis point hike at the Fed’s next meeting but not much more hiking after that. The sharp drop in the U.S. Dollar Index last week means currency traders are looking for the Fed to become more dovish. The dollar managed to rebound only slightly versus foreign currencies on Bullard’s remarks. Precious metals markets, meanwhile, are giving back some of their recent gains. However, bullion buying among retail investors continue to be robust amid tight supplies of available products from major mints. It doesn’t appear that the election results will have a significant impact on investor sentiment toward metals, as not much is going to change in Washington. President Joe Biden will still be able to ram through appointments requiring Senate confirmation. The Upper Chamber will continue to be controlled by Chuck Schumer and the Democrats. The House of Representatives will be narrowly controlled by Republicans. They announced their intention this week to launch investigations into some questionable financial dealings of Joe and Hunter Biden. That may score House Republicans some political points, but they won’t be able to produce any major legislative accomplishments without support from Democrats and ultimately a signature of approval by Joe Biden. The influence of elected officials on the economy and markets will continue to be overshadowed by central bankers who seem intent on inducing a recession in order try to tame the inflation monster they unleashed. Other central banks around the world, meanwhile, are growing wary of holding Federal Reserve notes and other forms of fiat as reserves. Many central banks are aggressively stockpiling hard money reserves in the form of gold. Global central bank purchases surged to nearly 400 tonnes in the third quarter. That represents the largest single quarter of monetary demand for gold on...

Another busy week is coming up for FX markets, featuring the minutes of the latest FOMC meeting and a rate decision in New Zealand that investors are split on. Most importantly, business surveys from the major economies will reveal whether US inflationary pressures continue to cool off and whether Europe is already in recession. 

After the rally driven by the low US CPI print, markets have traded more cautiously this week. US October retail sales growth surprised to the upside, signalling that the low inflation print did not necessarily reflect easing demand, as Fed would have hoped for. We continue to see near-term balance of inflation risks tilted to the upside, and expect the market optimism to turn out only temporary; in our latest FX Forecast Update - USD selloff to prove temporary, 14 November, we maintain our 12M EUR/USD forecast at 0.93. Geopolitics were on the agenda in the first G20 meeting after Russia's invasion to Ukraine. Joe Biden and Xi Jinping met for first time face-to-face after Biden became the president, and despite the past years' tensions, the leaders struck a more constructive tone, emphasizing that neither party wants to enter a new cold war and that communications lines would be reopened. That being said, we think that especially the Taiwan issue and the recent US tech restrictions will maintain tensions elevated; see our earlier paper: Research US-China: Long-term tensions are here to stay no matter the election result, 5 October. While the Democratic Party ended up performing better than expected in the US midterm elections, and managing to maintain the control of senate, republicans did narrowly clinch the control of house this week, ensuring a divided congress. For markets, the result is a positive (although broadly expected) outcome, as the divided congress is less likely to be able to pass potentially inflationary deficit spending measures. Markets will next focus on how the congress will be able to raise the US debt ceiling, which is expected to be hit early next year. So far, republicans' key demands for supporting the debt ceiling raise have been related to spending cuts to social security and Medicare, which would have limited impact on the broader economy, but which could be difficult for the democratic senate to pass. Europe will also focus on the continuation of US support to Ukraine, and while we do not expect an abrupt end to the support measures, the republican control of the house could mean that 'America first' style cost-cutting will be increasingly on the agenda as the recession looms. More broadly, while the war has so far united western nations to support a common ally, we see rising risks of US-EU relations turning sour going forward, see Euro macro notes - Transatlantic ties are in for a chill, 16 November. Next week, focus turns back towards the economic growth outlook, as November Flash PMIs are released on Wednesday. We expect the Euro Area figures to provide further evidence of contraction in the Q4 as inflation is weighing on demand and companies' order books, while we still foresee modest growth in the US economy. FOMC and ECB minutes will also be released on Wednesday and Thursday respectively, and while markets' focus remains on more forward-looking data, we will keep an eye out for any hints of the expected hiking pace in December (50 or 75bp) as well as ECB's view on the QT timeline. In China, focus remains on the rising Covid-cases and on any signs of potentially changing tolerance for the spread of the virus. We will also focus on any potential new easing measures after the October growth figures once again surprised to the downside this week. On the central bank front, we expect 75bp hikes by both the Riksbank on Thursday (see more below) and the Reserve Bank of New Zealand on Wednesday. Download The Full Weekly Focus

Summary United States: Even with Encouraging Inflation Developments, Economic Resilience Continues to Challenge the Fed In line with last week's CPI performance, the headline PPI increased 0.2% sequentially, two-tenths below expectations. The resiliency of the U.S. consumer was also on display, as total retail sales increased a stronger-than-expected 1.3% in October, boosted, in part, by a 1.3% jump in motor vehicles & parts and a 4.1% rise at gasoline stations. Weakness continued in the housing market, which is clearly in recession. Next week: Durable Goods Orders (Wed), New Home Sales (Wed) International: What's Going On with Global Inflation? This week, October CPI data were released for the U.K., Canada and Japan, highlighting diverging paths for inflation in each economy. In the U.K., headline CPI inflation rose to 11.1% year-over-year, with the electricity, gas and other fuels category up nearly 90% compared to last year. Meanwhile, headline inflation in Canada has receded from a recent peak, coming in at 6.9%, but underlying price pressures continue to intensify. Last, Japan's inflation is much more contained compared to the U.K. and Canada, although prices are elevated by recent historical standards. Headline inflation quickened to 3.7% in October. Next week: Australia PMIs (Wed), Eurozone PMIs (Wed), U.K. PMIs (Wed) Interest Rate Watch: Yield Curve Inversion Deepens Various points of the Treasury yield curve have inverted this year amid the Federal Reserve's aggressive policy tightening cycle. The spread between the yield on the two-year Treasury and the 10-year Treasury notes first turned negative in the spring and has become even more inverted in recent months, reaching a new low of -68 bps at the close on Thursday of this week. Topic of the Week: The Economics of the 2022 World Cup What is expected to be the most viewed sporting event in world history is back, as 32 nations compete in Qatar starting on Sunday for the 2022 FIFA World Cup. We take a look at the economics of Qatar as well as our own predictions for the tournament. Read the full report

Outlook: We are seeing a pullback in commodities, currencies and equity markets that does not arise from any particular economic event or data. This could be rising risk aversion but we can’t put a finger on a driving factor--nothing specific jumps out. The only real Big Event is the UK budget, and it’s not inconceivable that the market is still judging whether it wants to accept it. The budget proposal in a nutshell is “about £30 billion in spending cuts and £25 billion in tax increases, including a six-year freeze on income tax thresholds and lowering the top income tax rate to £125,000,” as Trading Economics puts it. The UK aside, the pullback in multiple asset classes may mean the pullback is pure positioning and therefore short-lived—not a reversal back to the primary trend. The US news today includes Oct housing starts, likely another drop but not as awful as Sept (-8.1%). We all know about the big and ongoing drop in house prices and seller reluctance, so an ongoing decline in starts is hardly surprising. The reversal in home inflation has two major effects—it can lower inflation reports generally going forward (shelter is 24% of CPI, if badly formulated). It can also drive GDP down. The Atlanta Fed knocked socks off with the latest GDPNow for real GDP growth in Q4. That’s seasonally adjusted and annual—and it’s a whopping 4.4% from 4.0% on Nov 9.  The driver is the growth of real personal consumption expenditures arising from the retail sales numbers yesterday. We get another update today. This information informs our opinion about inflation. You can get dizzy reading so many differing views on inflation, and it can be hard to pick apart arguments to find the key assumptions that determine outcomes. Here’s an argument that starts with a fully disclosed assumption: the American consumer is endlessly materialistic and greedy. He will continue to buy no matter where prices go. Poor people will buy because they need to eat, middle class people will run up credit card debt for the latest fashion, tech toy, and concert ticket, and rich people—well, rich people buy art, jewelry and more real estate (they already have yachts). The American consumer can continue to consume due to massive savings accumulated during the pandemic, plus recent wage gains and borrowing capacity. The NY Fed reported consumer borrowing up $351 billion in Q3. (Total household debt is $16.52 trillion…. ).  The persistence of inflation is the same picture worldwide. The Economist writes “We calculate that the prices of 67% of items in the average rich country’s inflation basket are rising by more than 4% year on year, up from 60% in June.” What about those nay-sayers at FedEx, Target and Amazon who say earnings are lousy because the customers are “stressed out” and sales are trending way down? The likely explanation is these are outliers. Others in the retail space are doing just fine. Granted, holiday spending is up in the air and might disappoint, and sales abound—but not all of the gains in retail sales can be attributed to inflation alone. Besides, the sales outlook is highly sector-dependent--home improvement and gardening up, electronics down. As Wolf Street writes, “In the early 1990s, department stores sales accounted for nearly 10% of total retail sales. In October 2022, they accounted for less than 1.9%--on track to irrelevancy.” Now take Assumption No. 2: unemployment will not go up all that much. The labor shortage is real and will persist. Wages will go up, if not as much as inflation in goods and services. Bottom line: Inflation may have peaked, but will remain high, say 4.5-5.5%, for several years. To imagine it will get back under 2% by end-2024 is a pipedream and inconsistent with what we know about the consumer—unless unemployment really does go nuts, as the Fed so fervently wishes. Granted, growth may slide downhill and the economy contract or grow only by fractions, but that will be due more to non-consumer behavior.  Assuming the Fed doesn’t chicken out, that chart showing Fed funds kissing 5% briefly but then retreating to as low as 3% by end 2024 is not realistic. One implication of this combination of factors—persistent high inflation AND strong consumption—is that the Phillips curve really is dead. Its demise has been heralded multiple times but it keeps coming back to mislead us. The inverse correlation of employment and inflation has some effect, but not a ruling one. Yellen is not at the Fed anymore but gave a speech at the Boston Fed in September in which she gives far more weight to inflation expectations than to the Phillips curve, never mentioned by name but noted as not having worked very well in the last recession. This may put us in the stagflation camp, and we...

Markets US stocks slid for the second day as Fed hawks continued to circle the wagons, repeatedly emphasizing their fight against inflation is far from done. So with investors beginning to question the validity of the post-CPI market moonshot, it effectively pushes out the process of getting constructive for next year. If the Fed raises Funds to 5% and then holds through the expected H1 2023 recession, that's hardly a good signal for equity markets. Broader markets are entirely in thrall to interest rates. Air pockets lower were evident in virtually every asset class as US 10-year Treasury yields climbed after St. Louis Fed President James Bullard said policymakers should increase interest rates to 5% to 5.25% to curb inflation. The S&P 500 and the tech-heavy Nasdaq 100 declined for the second consecutive session as the falling tide grounds all ships. Price actions suggest investors lack the necessary conviction above 4000 on the S & P 500. Things can turn on a dime, primarily when the fear of missing drives sentiment. However, the odds of a pre-Thanksgiving rally are giving way to the hawkish Fed drumbeat and pushback on China reopening plays.   Oil  Oil prices plummeted as traders dumped the China reopening play's and headed for the exits en masse as a confluence of bearish market forces bore down on the oil complex.  China's covid concerns are on everyone's mind, and with local surges giving rise to protracted lockdowns, oil prices are moving tangentially lower to that increasing probability. China's inflation threat, which suggests higher interest rates in the offing, is also a worrying signpost for the commodity space, particularly oil markets. The experiences of western economies won't be lost on the PBOC. And this is one of the rationales for markets to defer to a slower reopening, as it will mitigate the inflation angst suffered by western economies. The Fed's determination to fight inflation at all costs will increase the odds of a hard landing and could support the US dollar negatively for the oil markets for longer than expected.    Forex The dollar snapped a two-day drop while reminding investors of its Jekyll and Hyde persona regarding its correlation with risk assets framed by higher US yields.   Still, unless market pricing for the next three meetings steps up from the 100bp currently priced, given the time of year, it is hard to envision the EURUSD heading for parity again despite the pushback in the China reopening, which would have paid the Euro off in spades via the growth-inflation trade-off.