The two main reasons he cites are the potential for an escalation of the conflict between Israel and Hamas, and subpar fiscal conditions in the United States. While an inverted yield curve wasn’t included in Tudor’s comments, it’s yet another important factor for investors to consider.
Geopolitical conflicts exacerbate macro uncertainty
In a recent interview with CNBC, Jones mentioned the factors he’s keeping an eye on with regard to the Israel-Palestine conflict before deciding that market uncertainty has been reduced. His general thesis is that if things escalate further, a risk-off sentiment could prevail in financial markets.
Despite the potential for geopolitical tensions escalating in the near-term, the major U.S. indexes have all posted gains for the first two trading days of this week. If Jones is right, this rally will likely be short-lived.
The yield curve remains deeply inverted
One of the greatest predictors of recession historically has been the yield curve. Every recession since 1955 has been preceded by an inversion of the curve between the yields of the 2-year and 10-year Treasury Bonds.
In July, the 2s/10s yield curve for US Treasuries hit a low of 109.5 basis points (BPS). This level had not been seen since 1981. While this inversion has since steepened, things still look bad from the perspective of shorter duration Treasuries.
The 1-month and 3-month US T-bills are currently yielding close to 5.5%, while the 2-year note is yielding close to 4.96%. The 10-year is yielding 4.65%, meaning the 2s/10s curve is inverted by 31 BPS.
A flatter yield curve compresses margins for banks because it limits their ability to borrow cash at lower rates while lending at higher rates, which can lead to restricted lending activity and a resulting economic slowdown. It also means that investors are less optimistic about the near-term future of the economy, as they sell shorter duration debt, causing yields to rise.
The Federal Reserve’s attempt to fight inflation by raising rates at the fastest pace in modern history has also played a role. Higher rates create additional stress on the banking system, which has seen 3 of the 4 largest collapses in U.S. history this year alone with the failures of…