Signals given by some of the Asset Classes for the US Economy

Fed is likely to cut rates in September 2024 after muted economic growth data and lower than expected job growth data. Also, downward revision of reported jobs for FY 2023-24 by almost 8,00,000 did not help matters.

Generally, markets take a cue from this and scale new highs post rate cuts as lower interest rates are good for corporate balance sheets and retail consumers at large. However, history shows that this is the beginning of the end, markets may be topping and subsequently in a few months’ time, economy goes into recession, followed by major market drawdowns like 2000, 2008 & 2020. Following chart of Fed Fund rate since 1950s depicts this story – where grey bars are recessions post rate cuts.

If Fed cuts rate by 50 bps (against 25 bps), this may be cheered by markets, but what it may indicate is that Fed is worried about some of the data points (which we may not be aware of) and hence such aggressive rate cuts.

Some of the asset classes which are leading indicators of market macros are:

1. Dollar Index
2. 10 Year UST
3. Gold
4. Nasdaq Composite

3 of the above have made decisive moves – 10 Year UST and Gold on the upside and dollar index on the downside. Only one which is hovering in a narrow range is Nasdaq Composite which will, in all probability make its decisive downward move once rate cuts happen and recession sets in thereafter.

This time will be no different, in all probability markets will cheer rates cuts, scale new highs but US economy will go into recession soon thereafter, followed by major market drawdowns. In addition, there are many more factors that I had written about on 22^nd November’2023 a link of which is shared here -which points towards a fragile US economy (https://www.misterbond.in/article/reality-of-amrit-kal-is-india-totally-decoupled-from-global-factors)

Fed Funds rate since 1950s:

Source: https://fred.stlouisfed.org/series/FEDFUNDS

Now let us analyze what different asset classes are pointing towards or what signals are they giving about US economy in general. First let us see 10 Year US Treasury Yields. Generally, debt markets give more accurate signals about prevalent economic conditions than equity markets (which may be running on sentiments and liquidity). Fed has not cut rates but just given an indication of them cutting rates as and when data suggests a weakening economy. Despite that US 10 Year yield has come off from a high of 4.99% on 19^th October 2023 to currently below 4% at 3.90% - drop of more than 100 bps over past 1 year period. This points towards a shift of investment patterns by sophisticated investors from Equity to Debt to earn higher carry yields and possibility of capital gains once Fed starts to cut rates. Also, debt does well during recession – a shift of mind set on the part of investors and bracing for volatility going forward.  This indicates asset managers shifting from higher risk- less reward to lower risk-high reward asset classes.

10 Year UST:

Source: https://www.marketwatch.com/investing/bond/tmubmusd10y?countrycode=bx

This shift by sophisticated and institutional investors is visible from the amount of funds parked in US Money Market Funds – which has grown steadily over past 1 year and currently upwards of $5 trillion. This set of investors is surely seeing something which rest of the markets are not – which is possibility of recession post rate cuts by the Fed.

Source: https://www.financialresearch.gov/money-market-funds/

Dollar Index over past 3 years:

Source: https://www.marketwatch.com/investing/index/dxy

After touching a high of 113 in September 2022, it came crashing down to 101 by January 2023. Thereafter, it hovered in a narrow band of 104 to 106 for almost 18 to 24 months before going down once again to 102 levels currently. This is once again a decisive move by an index which reflects weakness in the US economy.

Gold Rates:

Source: https://tradingeconomics.com/commodity/gold

Movement in Gold rates is a major indicator of the weakness or strength in the economy. Pre-COVID Gold hovered in a narrow range and scaled a new high in August 2020 and breaking $2000/oz barrier. Thereafter, it moved in a narrow range of $1700 to $2000/oz till February 2024. It has once again broken out of this narrow range and scaled a new high of $2500/oz from Feb 2024 to now August 2024. This asset class indicates uncertainty of macro-economic factors and geo political tensions.

Gold rallied from a very low-price base in 1970 to an all time high in 1980. This period marked economic uncertainty, troubles in Middle East and acted as a safe haven. Thereafter, it stagnated for almost 20 years till 2000 before breaking out post dot com bubble, thereafter global financial crisis in 2008-09. It started gaining momentum post COVID crisis in 2020 and touched a peak of $1900/oz by August 2020. It remained sideways till almost September 2023 before breaking out of $2000/oz level from February 2024 to now crossing $2500/oz I August 2024. As can be seen from price movements in Gold (which happens in spurts followed a lull), it has performed well during economic uncertainty periods, periods of recessions and periods when there were geo-political tensions.

3 of the major macro indicators are pointing towards reallocation of funds from risky asset classes and create portfolios with low risk-high returns going forward. To summarize, strength in 10 year UST prices and Gold prices are indicating expectations of weakness in the markets moving ahead and dollar index going down once again indicates weakness in US economy. Only one asset class which is defying this trend and swimming against the tide is Equities.

Nasdaq Composite:

Source: https://www.google.com/finance/quote/.IXIC:INDEXNASDAQ?window=1Y

After touching a high of 18671 in July 2024, it collapsed to 16200 in August 2024 when Japanese Yen carry trade unwinding started. Post that it has recovered quite significantly back to 17,700 levels currently. But as can be seen from the chart, there is consolidation happening in this Index with almost sideways movement over past couple of weeks. This Index can scale new highs post rate cuts and make top.

To conclude, if we keep a close watch on some of the important asset classes and their price movements, they tell us a story of the economic strength or weakness. Only time will tell as to which asset classes have given the right signals on weak economy and which is trying to swim against the tide. If movement in 3 asset classes viz. Gold, 10 Year UST and Dollar Index proves to be correct in terms of economic weakness in US, 4^th asset class may have to follow soon.