Q2 Earnings Update
Investors have been absorbing a number of prominent Q2 earnings report this past week, many of which indicated a slower economy and as was expected, a resilience in the profits and the outlooks.
Yield Curve Inversion
For the second time this year, the yield curve inverted, as the yield of the 2-year U.S Treasury bond rose above the yield of the 10-year bond on Tuesday, which usually indicates the possibility of a recession in the future.
The yield curve is basically a line plot chart that graphs out the yield, or interest rate of U.S. Treasuries at different maturities, or the date when the principal investment must be paid back. Treasuries are one of the safest investments as it is backed by the full faith and credit of the U.S. government and investors are guaranteed the return of their principal investment and interest if held till maturity. During ‘normal’ economic times the shorter-term Treasury yield will be lower than longer-term Treasuries because as logic would suggest, a person holding a Treasury longer would have to be rewarded more for the longer period of risk they are willing to take, and this is shown in the image below.
On the contrary, if an yield curve is ‘inverted’, it means shorter-term Treasuries have a higher yield than longer-term Treasuries, and historically, an inverted yield curve has been viewed as a major indicator of a pending economic recession as market sentiment suggests a poor long-term outlook amd the longer term yields will continue to fall.
One of the most popular ways to measure the yield curve is by calculating the spread between the ten-year Treasury yield and the two-year Treasury yield. This spread is one of the most accurate recession indicators ever. Since the time this data was published in 1976, this spread has accurately predicted every declared recession in the U.S.
The shaded years in the above graph provided by the Federal Reserve indicates a recession, and what we can clearly see is that every time the two-year Treasury yield is greater than the ten-year yield Treasury yield, leading to a negative spread, a recession follows.
A similar pattern was seen last week leading to increasing concerns of a recession. While rate increases can be weapon against inflation, it can also slow economic growth by raising borrowing costs for everything. When short-term rates increase, U.S. banks raise benchmark rates for a wide range of consumers and commercial loans.
|Index||Week Open||Week Close||% Change|
|Dow Jones Industrial||31,097.26||31,338.15||-1.28%|
- U.S. stocks posted moderate weekly gains, reversing the negative trends of the previous week.
- There was a wide divergence across the major indexes with the Nasdaq gaining almost 5%, while the S&P 500 adding 2%
- The price of U.S. crude oil fell below $100/barrel on Tuesday for the first time since early May.
We are set to enter into the next earnings season as we are into the second week of the month. Relative to recent quarters, expectations are low heading into the earnings season. Meanwhile, the U.S. labour market continued to post strong growth in June by generating 372,000 new jobs, keeping the unemployment rate steady at 3.6%. Key market updates to watch this week include the U.S. CPI data release and the Bank of Canada interest rate announcement on Wednesday.