Chart of the Day: Something is Wrong in the Economy – This Correlation Makes No Sense

Sometimes correlations have causation, and other times they do not. For example, all cancer patients eat pickles, so there for pickles cause cancer. But here is a financial causation that is quite interesting – 10-year treasuries vs. the ISM Manufacturing index. In this case, this relationship has had a long history of correlation. But it’s out of sync – what’s going on?

Bond yields are predominately a function of economic activity, expected inflation rates, and the balance between the supply and demand for bonds.

Economic activity correlates well with bond yields for a couple of reasons. When the economy slows, inflation tends to weaken, thus making bond yields more attractive. Second, in times of economic weakness and uncertainty, investors often reduce exposure to risky assets in favor of more conservative ones, such as Treasury bonds.

The graph below shows the relationship between the ISM Manufacturing Index, a strong proxy for economic activity, and ten-year UST yields. Before 2022 the positive correlation was relatively strong. As we circle, the relationship has reversed this year. Yields are rising despite weaker ISM readings. See this in the chart below and learn more here.

This out-of-sync correlation is getting worse with the recent CPI print of 8.3%, that worse than expected and caused rate expectations only to heighten another 100 basis points. See below and learn more here.

Rate Hike Expecations 2022-09-15Meanwhile, the economy continues to stagnate and trend down. US Industrial Production fell in August, dropping 0.2% MoM (vs. 0.0% expected), and saw July revised lower also. August was the biggest MoM drop since Sept 2021. See this in the chart below and learn more here.

Industrial Production 2022-09-15

Some believe this correlation is being distorted because of quantitative tightening that causes the supply of bonds to increase, dropping prices, and raising yields. But this would increase the out of synchronization of this correlation, not make it better.

One of two things is going to happen to bring this correlation back into synchronization with historical trends.

  • The economy is set to boom, bringing up the ISM Manufacturing Index. With rising rates, this is unlikely to happen – see here and here that show evidence of this.
  • The Fed will pivot, and rates will come down, reducing the 10-Year Treasury yields to bring the correlation back into line. But the downside of this is that the 40-year high inflation would get worse.

So what will happen? Even financial elites are getting worried. JPMorgan Chase CEO Jamie Dimon says he is preparing the biggest US bank for an economic hurricane on the horizon and advised investors to do the same.

Often correlations that get out of sync will hit extremes, causing great financial pain. Then only to reverse with continuing great financial pain. These out-of-sync whipsawing correlations can be horrific but are sure to happen like a hurricane’s front and back sides.

Many others also see these same issues – like Jamie Dimon of JPMorgan Chase. However, the everyday American may not be, and we point out these unfortunate realities to get people to think of the consequences of who they choose as their leaders. Stay tuned to this thread Chart of the Day, and we will provide regular financial hurricane reports to guide you the best we can.

We agree with Jamie Dimon – a “hurricane is coming.” Prepare accordingly …

If you found this article informative, please consider a small donation to our coffee cup to help support Conservative Journalism – or spread the word. Thank you.

See more Chart of the Day posts.

 RWR original article syndication source.

Tom Williams

Source link