Financial market volatility doesn't show signs of letting up anytime soon. The mounting signs of global economic weakness as central banks continue to raise interest rates, along with building worries over financial stability all add to the volatility. Bond yields continue to climb, along with the US dollar, as equities and house prices decline.
Treasury Yields Soar
Treasury yields in the U.S. jumped the week of September 21-28 after the Federal Reserve (Fed) raised rates by 75bp to 3.25% on September 21. The yield on the 10-year U.S. government bonds briefly touched 4.0% on September 28 for the first time since April 2010. The 2-year Treasury yield climbed to 4.3% (a 15-year high) and the result was a yield curve inversion which occurs when shorter-term government bonds have higher yields than long-term bonds. An inverted yield curve is a strong indicator of a future recession. Hawkish Fed speeches confirmed the central bank’s commitment to bring inflation back to its 2.0% target even at the risk of recession. With inflation still looming, the Fed will likely raise rates further, our baseline forecast is for a 75bps hike at the November 2 meeting, with another 50bps hike at the December meeting which would bring the fed funds rate to 4.5%. We think that the Fed will then likely hold before reversing course in the second half of 2023 as inflation pressures subside somewhat and economic growth weakens.
Our baseline forecast is for the Bank of Canada (BoC) to raise 50bps at the October 26 meeting and anther 50bps at the December 7 meeting to bringing the BoC target rate to 4.25% at year end.
Mortgage Rates Rise
On September 28, the average US 30-year fixed rate mortgage popped to 7.1% — up a staggering 3.9% higher than a year ago and a 1.8% jump since August 2022. The demand from homebuyers has fallen 29% since last year as a result of rates surging past 6%. In Canada, the average mortgage rate offered by major banks stands around 5..3% for 5-year fixed mortgage.
The expected rise in interest rates will bring mortgage rates in Canada to over 6.0 % for a five-year fixed in Canada by year end. This additional rise in rates will cause further downward pressure for house prices. The Canadian Real Estate Association has cut its forecast for home sales in Canada this year by 20%-30% depending on location. Buyers appear to be on the sidelines until they see clearer signs of borrowing costs and home prices stabilizing.
Stock Markets Sell Off
The century-old Dow Theory sell signal of a continuing pattern of lower peaks and troughs was confirmed on Friday, September 23 when the Dow Jones Industrial Average (DJIA) tumbled by 767 points and closed below the June 17 low of 29,888.78. The Dow Jones Transportation Average broke the June closing low on September 16 dropping by 2.51%. When both indices close below their previous lows, they complete a “sell signal” known as the Dow Theory.
On September 30, the Dow Jones set a year-to-date low of 28,726 — a steep drop of 21.9% from the year-to-date high of 36,799.65 set on Janu 4. The S&P 500 has declined more than 25% and the NASDAQ over 34% year-to-date. Growth stocks have been hit particularly hard prompting Cathie Wood, with her ARK Innovation ETF is down more than 70% since its November 2021 high, to pen an open letter to the Fed urging them to stop raising interest rates. or risk an economic "bust". The letter, posted on the firm's website, encourages the Fed to look at leading indicator data such as the decline in commodity prices, instead of lagging indicators, such as employment, data.
US Dollar Climbs Further
The U.S. Dollar Index has surged 20% this year, while the U.S. stock market has plunged approximately 25%. The recent rally in the U.S. dollar is creating a chaotic situation for risk assets including stocks. With the dollar strengthening over the past year, American consumers have benefited from cheaper imports and less expensive foreign travel. Multinational companies with large sales in the U.S. and that earn income in U.S. dollars have benefited. At the same time, American companies that export or rely on global markets for the bulk of their sales have been negatively impacted. We expect the US dollar to continue its uptrend through first quarter 2023, but then as the Fed contemplates reversing course and US economic weakness becomes more apparent politicians are likely to start discussing ways to 'devalue' the U.S. to help support the economy and 'bring jobs to the U.S.
Commodities Plummet Oil
WTI crude futures have declined more than 25% since June. OPECE slashed its oil-demand forecasts and its global growth forecasts. The reasons cited for slower growth were elevated inflation, rising interest rates, and geopolitical tensions. The slowdown in demand is justification for OPEC's decision to cut supply by 2 million barrels a day. The report stated that the supply cut was "pre-emptively and proactively" aimed at balancing supply with weakening demand.
The price of gold closed the month of September at approximately $1670 USD per ounce marking the sixth straight month of decline. The metal is trading close 20% below the year-to-date high of $2,074.60 set on March 8, 2022. The gold price has faced significant headwinds of a surging U.S. dollar and surging real-interest rates. Despite the short-term bearishness in gold, we are still bullish over the medium and long-term. The extreme debt levels, over leverage and fragility of the financial system are a few of our long-term bullish factors.
Russia Ukraine War Persists
On September 30, Russia annexed four regions in Ukraine after holding referendums in parts of occupied Ukraine territory. The annexation marks the largest forcible takeover of territory in Europe since the second world war. President Biden said the U.S. will never recognize the annexed territories as being part of Russia. President Zelensky announced he is applying for fast-track membership in the NATO alliance and Biden said he is prepared to defend every inch of NATO territory. Moscow, for its part, has warned it has “the right” to use nuclear weapons to defend its territory and citizens if it feels there is an existential threat, or even if it’s attacked by conventional weapons.
Start building a position in silver. Interest rates and the U.S. dollar won’t go up forever and the pivot to precious metals will be extreme when the time comes. Another factor in silvers favour is that inflation will likely stay somewhat higher than pre-covid.
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