Last week was a big week for markets, as the trade war that everyone has been warning about has finally arrived. Despite what some of our most epic posters might tell you, the trade war is not off (the China tariffs are still on despite the 30 day delays for the ones on Canada and Mexico) and that was not a successful bluff by Trump to get Canada to do what it already pledged to do, and I can prove it with math.
The largest, most liquid market in the world spent last week sending the biggest, scariest warning signal it can: an inverted yield curve.
I touched on this last Monday in my summary of how markets reacted after they admitted they were not prepared for Trump to do what he said he would do and did before, and the concerns being revealed by the divergence between the two-year and ten-year Treasury Notes. But it wasn’t just those two that flashed a big red signal with the word “recession” in the middle of it, it was all the biggest players in the United States Treasury’s portfolio of government debt. Last week’s net returns for the one-, two-, three-, five-, seven-, ten-, twenty- and thirty-year Treasury yields all paint a very clear picture of what the smartest market in the world thinks of Trump’s policies (here’s the spreadsheet I’ll be using to track these going forward).
While the yield curve has not inverted (the rates paid on Treasuries would need to be descending from highest to lowest), the returns last week did invert to a degree (one-year excepted). It’s also pretty telling how quickly the net return falls off between the three- and five-year notes, as one of those will mature during Trump’s second term and the other will not, providing the market with a very clear signal that Trump’s policies in the near-term threaten to raise inflation. If these returns on yields continued in this direction, the yield curve would eventually invert, which is very, very, very bad.
An inverted yield curve means the market expects high inflation in the short term and low growth in the long run. This is the exact “Trump trade” put on by analysts at Barclays and Morgan Stanley last year that is currently in profit, and the only way to interpret this movement in yields is that the market is at least preparing itself for recessionary dynamics to hit. If the bond market believed that Trump’s trade war and Elon illegally controlling the Treasury’s purse strings would lead to economic growth, you would see the opposite dynamic in treasuries, with the longer-term debt rates growing at a faster pace than short-term debt.
Now this is not definitive. One week does not make a trend, and so far this morning, the yield curve is not following the same inverted move it made last week. This could be a mean reversion, it could be a response to something more granular or a mixture of any number of things. The comparison of markets to aircraft carriers is apt, as you can’t just pull a hairpin turn on a dime with one of the largest and most powerful machines men has ever created. It takes time for an aircraft carrier to change direction, and this is especially true of the largest, most liquid market in the world.
So it’s worth keeping an eye on Treasuries going forward given that Elon and Trump are doing their best to attack the full faith and credit of the United States government. The stock market gets all the attention in our financial media, but there’s a reason why smart money in the stock market looks to the smarter money in the bond market for their macro signals. It’s too early to say for certain what the bond market interprets Trump’s policies to be, but after one week under his trade war, it’s clear as day that it looks at a recession as a very real possibility and is actively positioning itself for it.
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