Recessionary regime shift
This is a quick note as I’m traveling, but the market has shifting markedly against my views in my last post, and I need to send an update.
The price action in equities and Treasuries over the last 24 hours shows a strong shift towards a recession regime, which is when volatility expands and both equities and yields go down. My bullish call on equities and crypto on Monday was poorly timed. I was right for about a day - risk appetite improved following Powell’s FOMC statement and confirmation that rate cuts are coming. However, the following day saw two worrying data points - jobless claims came in at a high in the economic cycle of 249k, well above the 236k expected, and the ISM manufacturing employment index came in at 43.4, well below expectations and at levels consistent with inflation. The S&P 500 proceeded to fall sharply afterwards and Treasuries rallied violently, led by the front end of the curve.
We have been getting weak prints like this throughout the last three months and they haven’t resulted in such a strong market reaction. My theory about why the market reacted like this is that larger institutions that trade on a medium to long term time from (think pension funds and sovereign wealth funds) have been patiently waiting for the Fed’s easing cycle to begin. Most have been sitting in Tbills and holding out on moving out into the maturity curve. We are likely seeing a tipping point where larger institutions are collectively positioning for an economic recession and a deep Fed cutting cycle. How deep? Every previous recession has required real interest rates to go negative in some part of the curve (usually the front end at the very least) to ease financial conditions enough to recover. With CPI at 3.0% and core PCE at 2.6%, this means a Fed funds rate or terminal rate at 2-2.5%. If the US economy is indeed tipping into recession, the Fed would need to act swiftly and deliver these cuts within the next 2-4 quarters. This means a terminal rate of 2-2.5% by the middle of next year, equating to 97.35-97.85 in the June 2025 SOFR contract (current market is 96.35). There is tremendous upside in this market if recession fears come to pass, so my plan will be to go long on dips (which might happen if we get a knee-jerk dip on the NFP number today).
It’s frustrating to write this as I have been bullish and long SOFRs at various points this year, but was shaken out multiple times by price, strong economic data, and Trump’s election odds. Right idea, but poor execution. Is it painful to be chasing the market after it has moved 30-40 bp in my direction without my participation? Of course. However, this shouldn’t cloud my view or trading when price and fundamentals align in favor of my view. I’ll be keeping paid subscribers updated in the Substack chat on when I decide to act on this trade.
Disclaimer: The content of this blog is provided for informational and educational purposes only and should not be construed as professional financial advice, investment recommendations, or a solicitation to buy or sell any securities or instruments. The blog is not a trade signaling service and the author strongly discourages readers from following his trades without experience and doing research on those markets. The author of this blog is not a registered investment advisor or financial planner. The information presented on this blog is based on personal research and experience, and should not be considered as personalized investment advice. Any investment or trading decisions you make based on the content of this blog are at your own risk. Past performance is not indicative of future results. All investments carry the risk of loss, and there is no guarantee that any trade or strategy discussed in this blog will be profitable or suitable for your specific situation. The author of this blog disclaims any and all liability relating to any actions taken or not taken based on the content of this blog. The author of this blog is not responsible for any losses, damages, or liabilities that may arise from the use or misuse of the information provided.