Signals Flashing

• US stocks finished mixed on Tuesday, as investors prepared for a crucial inflation report expected to influence the Federal Reserve's upcoming interest rate cuts.

• The S&P 500 added 0.4%, marking its second straight winning day, while the Dow Jones lost 92 points, driven by steep losses in banking stocks.

• Tech stocks, including Nvidia (+1.5%), Microsoft (+2.1%) and Amazon (+2.4%), provided some support, lifting the Nasdaq 100 by 0.9%.

• Among other stocks, Oracle shares soared 11.5% after beating earnings estimates and securing a deal with Amazon Web Services.

• Apple closed 0.3% lower amid a court defeat over its $14 billion tax dispute in Ireland.

Building on our discussion from last week, the Fed specifically went after jobs as the mechanism to bring down demand, and therefore bring down inflation from multi-decade highs.

The question is, did it come at the expense of an economic recession?

There are signals flashing. Take a look at the 2-year yield …

The 2-year is now down more than 80 basis points from late July.

That's 175 basis points lower than the Fed Funds rate. The bond market is telling us the Fed is way behind the curve — too slow to recognise the deterioration in the job market (and the economy).

So, the front end of the yield curve has collapsed, and the yield curve is now positive sloping, after two years of inversion.

Yield curve inversions are historically predictors of recession. When the curve turns positive again, it tends to indicate an economy has either entered or is about to enter recession.

What else is flashing a warning signal?

Oil is down 13% in seven days, trading near the lows of the past three years.  The last time we had a seven-day decline of that magnitude was March of 2023, surrounding the bank shock.

Of course, the bank shock was cleaned up with more central bank intervention.  Similarly, the recent carry trade shock was, at the very least, curbed through verbal intervention (by the Bank of Japan).

So, we have some signals flashing in a world where central banks have made a habit of cancelling market signals.