Rising Recession Risks: Fed's Rate Decisions Under Scrutiny as USD Falters

Is a recession in? We saw huge sell off on the dollar stocks & crypto while save haven assets like gold continue to make new all time highs. The US Dollar (USD) is facing significant pressures amid a deteriorating labor market and broader economic concerns. Recent data and analysis indicate that the Federal Reserve's cautious stance on interest rates might be insufficient to prevent a recession, raising critical questions about future monetary policy.

A Look At Treasury Yields

Yield curve inversion is usually a bearish sign for the stock market. In fact, every time since WWII, an inversion was followed by a recession between 6 and 18 months after. The yields that are used in the inversion chart are the 10 year and 3 month treasury yield spread. The spread is a simple subtraction of the 10 year minus the 3 month to get the spread. When the chart reads below the red line, it means the yields are currently inverted. It is structured this way to show that a lower negative number suggests the more overvalued the spread. As a leading indication of economic recessions, this chart is closely monitored by many investors. Looking at the chart we been inverted since October 2022 there after the dollar dropped roughly 13%. We can now observe since April 2024 the inversion has been on the decline. 0% is the midpoint, just this previous week alone we fell from -1.15% reading to a -1.34%.

Labor Market and the USD: A Troubling Scenario

NBC FX analysts Stéfane Marion and Kyle Dahms highlight that the USD is under pressure due to the worsening US labor market. The unemployment rate increased to 4.3% in July, surpassing the Federal Open Market Committee's (FOMC) year-end projection of 4%. Fed Chair Jerome Powell's focus on achieving full employment suggests potential for more aggressive monetary easing. Despite this, the analysts believe the USD's weakness will be temporary, as a global economic slowdown typically strengthens the dollar through risk-off trading.

Following July's disappointing jobs report, where non farm payrolls grew by only 114,000 against the expected 175,000, roughly a 60k difference. The USD faced heavy selling pressure, with the DXY index dropping to its lowest level since March. The unemployment rate's rise and a decline in average hourly earnings' wage inflation to 3.6% have heightened expectations for a September rate cut, with the CME FedWatch Tool indicating a 90% chance of a half-point cut. The DXY index's outlook has turned bearish, slipping below key Simple Moving Averages, signaling potential further weakness.

The chart below is of NFP since 2023 you can see the huge drop in the number of paid workers since Feb 2023.

Fed's Stance and Economic Indicators: A Mixed Bag

The Federal Reserve's recent decision to hold interest rates steady has drawn criticism and concern. Although the Fed adjusted its tone, acknowledging moderating job gains and rising unemployment as signs of a cooling economy, many believe this response may be too slow. Since May, US economic data has increasingly surprised to the downside, with signs of a slowdown evident since late 2023. Full-time household employment has weakened, and credit card delinquencies have risen above pre-pandemic levels.

Despite avoiding a forecasted recession in 2023, underlying economic issues persist. Government spending and public sector hiring have bolstered growth, but consumer spending on essentials outpaces income growth. Leading indicators such as the ISM manufacturing New Orders Index, which is in contraction territory, and rising jobless claims, suggest troubling economic trends. Small businesses are cutting hiring plans, and many consumer-facing companies have reported earnings misses.

A look at Stocks & Volatility

Looking at the put to call ratio you can see we've had a significant increase in bearish sentiment with more puts being placed vs calls in the options market.

Looking at dxy vix & the indices the market is currently in a state of fear. The environment is what is known as risk off. Where assets that are known to be less risky are gravitated towards. Like bonds & gold... people are more likely to hold onto their cash as well

Market Reactions and Future Prospects: Recession Risks Loom

Market signals, including the bond yield curve and stretched stock valuations, indicate a high chance of recession. The New York Fed estimates an over 50% chance of a recession in the coming year. The concentration of the S&P 500 index, with a significant portion in tech stocks, makes it vulnerable to corrections in the bullish AI narrative.

Economists argue that the Fed should have cut rates earlier and might need to take more aggressive action than initially planned. Mark Zandi from Moody's and Gregory Daco from EY Parthenon suggest that a precautionary cut in July could have mitigated current risks. Senator Elizabeth Warren has also called for immediate rate cuts to prevent economic downturn.

As the Fed debates its next moves, the risk of having to implement larger cuts by September becomes more likely. Goldman Sachs estimates the optimal interest rate to be closer to 4%, suggesting current rates are too restrictive. The potential for a self-reinforcing economic slowdown, with rising joblessness, delinquencies, and bankruptcies, could turn a soft-landing scenario into a full-blown recession.

Rate Cuts Pending

The US economic data is showing all signs of the need for a rate cut as soon as September. The catalyst for this will be a fall in the dollar. Would be nice to see us hold some sort of upside until then but that is indicative based on the economic news events released this month vs last.

Conclusion: Navigating a Complex Economic Landscape

The US Dollar and broader economic outlook remain fraught with uncertainty. As the Federal Reserve contemplates its next steps, the implications of recent labor market data and economic indicators will play a crucial role. Balancing the need for monetary easing against the risks of an overheated market and potential recession will require careful navigation in the months ahead. The coming decisions by the Fed will be pivotal in shaping the economic trajectory and the stability of the USD in a volatile global landscape.

From a Technical Analysis Standpoint

DXY just recently tapped into a monthly demand zone which from this time frame looks like we have SSL at 102.356 as the draw on liquidity (longer term) https://www.tradingview.com/x/eNIuA1BH/

On the weekly it becomes clearer that this liquidity is the draw w/ some potential upside direction following after https://www.tradingview.com/x/jt9snuzC/

On the daily we can see some potential upside this week actually, & we will release more data in another article on a deeper dive on this. Two scenarios in mind is we come a little further down before a fake out to the upside & then down trajectory to take out the draw on liquidity, or we take out SSL & reverse to the upside https://www.tradingview.com/x/1bao6yHH/

A brief video analysis can be found here https://vimeo.com/994799898?share=copy

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