Key Points
- The S&P Global US Composite flash PMI shot up to 58.4% for September.
- 10-year Treasury yields jumped to 5.114%.
- We expect 10-year yields to climb higher, causing a correction in stocks.
- The S&P 500 retreated, heading for a test of support between 7500 and 7600.
The S&P Global US Composite flash PMI shot up to 58.4%, the fourth consecutive month of accelerating growth and the strongest expansion in private-sector activity since July 2021.
The move was echoed by a healthy rise in the European Union’s equivalent flash PMI to 53.1%.
The surge in economic activity boosted market expectations of further Fed rate hikes, with the 2-year Treasury yield jumping to 4.876% compared to the current Fed funds target range of 3.75% – 4.00%.
The 10-year yield broke through resistance at 5.0%, closing at 5.114%, the highest level in more than 20 years. We expect a retracement to test the new support level, but respect will likely confirm another advance. Our medium-term target is 6.0%.
The S&P 500 retreated to 7700 and is headed for a test of support between 7500 and 7600. A breach would signal a correction to test primary support at 7300.
The Outlook for Treasuries
The spread between the 10-year and 2-year Treasury yields is shrinking as in previous Fed rate-hiking cycles (red arrows below). A dip below zero typically precedes a recession. The dip below zero from 2022-2024 was an exception, caused by the unprecedented scale of fiscal and monetary stimulus during the pandemic.
The Atlanta Fed’s GDPNow model projects real GDP growth of 5.1% in the third quarter, a 3.6% increase from Q2.
Even without an increase in the GDP deflator, driven by rising energy prices, we expect nominal GDP to jump from an annual rate of 6.6% in Q2 to more than 10.0% in Q3.
The strong divergence between nominal GDP and the 10-year Treasury yield would signal massive monetary stimulus, causing a sharp increase in inflation.
Conclusion
The Fed is trapped in an inflationary boom that will likely drive long-term yields much higher than 5.0%. Rising interest rates will increase the interest cost on the US Treasury’s $40 trillion debt, expanding the budget deficit above $2.0 trillion.
The Fed is constrained by its swollen balance sheet and will likely resist further QE to suppress long-term interest rates and assist the US Treasury.
Surging economic activity, compounded by crude oil and diesel supply shortages, is also expected to drive a sharp increase in inflation, adding to the Fed’s challenges.
Something has to break, and we are adopting a highly defensive posture, heavily overweight in Gold, short-term financial instruments, and defensive stocks with strong pricing power and stable income streams.
Acknowledgments
- Federal Reserve of St. Louis: FRED Data
- CNBC: 2-Year Treasury Yield
- Trading Economics: S&P Global US & EU Flash Composite PMI
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He founded PVT Capital (AFSL number 546090), which provides income and growth strategies to wholesale clients.
Colin also co-founded Incredible Charts and writes the popular Patient Investor newsletter.
Using a top-down approach, Colin identifies macro trends in the global economy and then combines fundamental and technical analysis to evaluate opportunities in sectors that stand to benefit.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.