Don't Celebrate Collapsing Commodities And Yield Curves

From what I gather, there’s a lot of bullish optimism building that the collapse in commodity prices and drop in bond yields is something to be celebrated. The breakout in the U.S. dollar tells us it is not.

The dollar’s been the most reliable indicator of inflation-driven stress in the U.S. economy since June 2021, when it reversed higher on hawkish language from former Federal Reserve Vice Chair Richard Clarida. That was the first clear sign that the Fed was falling behind the curve and would have to act sooner than had been signaled up to that point. Most investors missed the significance of this event because they were too focused on the slide in bond yields at the time, misinterpreting that move as a sign the Fed wouldn’t have to hike. Don’t make the same mistake again. The last time the dollar was breaking out like this was during the Dot-Com peak when interest rates brought down the stock market.

The dollar’s trajectory should be seen as a reflection of the tradeoff between growth and inflation, where a stronger dollar correlates with an economy under pressure from inflation and/or rate hikes. After a big swoon in May and a period of constructive technical consolidation the past month, the U.S. dollar is now breaking out again. The message: the Fed will be persistent in hiking rates even if inflation peaks or the economy slows.

And indeed, all signs point to a slowing economy. For the first time in two years, the spread between the 10-year and 3-month Treasury yields is collapsing. It is just so improbable that this is not a bad thing. It’s the only yield curve that was steadily rising from the invention of vaccines through this spring’s powerful thrust of economic reopening. Its uptrend breaking at the same time as commodity prices suggests rate hikes are already having a deleterious effect on the economy.

Stocks are still in a downtrend. Bitcoin remains pinned at $20,000. Even the big rally in bonds fits within the technical uptrend for yields, so far. The two big things that’ve changed the past week are the breakout in the dollar and the collapse in the 10-year/3-month curve. Neither are bullish events for the stock market.

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