Inflation Swaps, Yield Curve, and USDJPY Hint at Market Shifts
Stocks finished the day flat, in a fairly uneventful day. It was the lightest volume day on the S&P 500 futures since July 3, a half-day. Just 821,000 contracts traded today.
There isn’t much happening this week. Even the data calendar is light, with the highlights coming on Thursday in the form of jobless claims and Flash PMI readings, along with a very rare 30-Year TIPS auction. Otherwise, all eyes will be on Jay Powell’s Jackson Hole speech on Friday morning. This year’s Jackson Hole speech will be Powell’s last. Jackson Hole used to be a major event—especially in the years following the GFC, when Ben Bernanke often gave the market hints about QE. In more recent years, it has been used to signal the policy path for rate hikes and cuts. This year, it isn’t clear what Powell will say. I don’t think he is in a rush to cut rates, not with inflation still running hot. I would be surprised if he gave that signal ahead of next week’s PCE data and the August jobs report the week after. My guess is he’ll stay out of the spotlight and avoid drawing attention to himself, so as not to invite further criticism from Trump.
Looking at inflation swap pricing, I could easily argue that Powell shouldn’t signal anything. The 5-Year swap remains at the upper end of its trading range and still looks like it could move considerably higher. It even resembles an inverse head-and-shoulders pattern, but we’re still waiting to see if it can clear the neckline.
In the meantime, the USDJPY 5-year forward is getting very close to breaking out. Historically, when we’ve seen large moves in the JPY 5-year forward, they have coincided with major risk-off events in the S&P 500—see 2001, 2007, 2008, and 2020 in the chart below.
Of course, just because something looks like it’s about to break out doesn’t mean it will. But it does suggest the conditions are in place for one. And I can think of plenty of reasons why it might.
Meanwhile, we are starting to see some progress on the yield curve, with the 30-year minus the 3-month rising to 70 bps today. Perhaps it is forming the largest cup and handle pattern ever; I don't know, but the case for a steeper curve remains.
-Mike
Terms by ChatGPT
Defined Terms and Jargon
S&P 500 Futures: Contracts that allow investors to speculate on or hedge against the future value of the S&P 500 index.
Flash PMI (Purchasing Managers’ Index): A preliminary reading of economic activity in manufacturing and services, offering an early view of growth trends.
TIPS (Treasury Inflation-Protected Securities): U.S. government bonds designed to protect investors from inflation, with principal adjusted based on CPI changes.
Jackson Hole Speech: An annual economic symposium hosted by the Federal Reserve Bank of Kansas City, where Fed chairs often signal future monetary policy.
GFC (Global Financial Crisis): The severe worldwide financial crisis of 2007–2009.
QE (Quantitative Easing): A central bank policy of buying financial assets to inject liquidity into the economy and lower long-term interest rates.
Inflation Swap: A derivative contract allowing investors to exchange fixed interest payments for payments tied to actual inflation, used to hedge or speculate on inflation.
Inverse Head-and-Shoulders Pattern: A bullish chart formation in technical analysis that signals a potential reversal of a downtrend.
USDJPY 5-Year Forward: A long-dated currency derivative contract that reflects expectations of the exchange rate between the U.S. dollar and Japanese yen five years in the future.
Risk-Off Events: Market conditions in which investors reduce exposure to risky assets (like stocks) and shift toward safer investments (like bonds or cash).
Yield Curve (30-Year Minus 3-Month): A measure of the difference between long-term and short-term interest rates; steepening often signals improving growth expectations.
Cup and Handle Pattern: A bullish technical pattern in which a chart forms a rounded “cup” followed by a smaller consolidation (“handle”), suggesting potential upward continuation.
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