"Hideously inverted" yield curve darkens equities outlook

DEEPENING YIELD CURVE INVERSION DARKENS EQUITIES OUTLOOK (1306 GMT)

Market watchers are keeping a close eye on the the U.S. Treasury yield curve, which yesterday was at its most inverted since 1981, stoking concern about the prospect of recession.

Virtually every time the yield on the two-note has crossed above that of the 10 year (US2US10=TWEB), a recession has followed.

Yesterday it deepened to -85.20 basis points. The picture today is a bit better, at -84.30.

In a recent note, Citi analysts said the yield curve inversion is likely near a peak and at recent levels may even be somewhat overdone.

“Our model argues 2s-10s inversion may average around 60 bp over the next several months before the curve starts steepening in Q2 of next year—around when we expect the Fed to hit its terminal rate in this cycle," they wrote in a note.

The inversion is a major dampener on the outlook for equities.

"The yield curve is hideously inverted, recession is coming, and stock markets usually bottom only after a recession has started," write Deutsche Bank researchers in their 'Top ten themes for 2023' note published on Thursday.

"But when the outlook is overwhelmingly negative, and no one is positioned for good news, markets can bounce on any unexpected positives that do arise."

Given there are several scenarios where good news on big events could occur in 2023, they add, investors have to ask themselves whether they should chase what may be another bear market rally, or whether any positive boost could "finally be the real deal."

In a year-ahead outlook, J.P. Morgan analysts say their Regional Business Cycle Indicators show Europe at lows last seen in 2008 and 2020.

"...it has bottomed only after the yield curve steepens, never before," they write.

(Lucy Raitano)

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"FEELING THE SQUEEZE": LESS SPENDING, COOL DOWN HIRING (1126 GMT)

In a regular attempt to join the dots between top-down forecasting and the mood in the real world, Credit Suisse has again reached out to a panel of top executives at large European corporates.

The main takeaway this time is that Europe Inc is "feeling the squeeze" of rising rates and inflationary pressures, which in turn is leading to a reassessment of spending plans in a potential threat to the economic cycle. It also looks that hiring plans could slow down.

"Concerns over the demand background are obviously weighing on corporate budgets but, worryingly, we are seeing a squeeze posed by access to external financing, bank or capital market," say CS analysts led by Richard Kersley.

"The weakening in spending plans over the last year has been reflected in falling momentum in every category of spending intentions. Travel, advertising and IT have stood out for their momentum shift as we flagged in our last survey," they add.

"Away from these areas, catching the eye is the first sign of hiring intentions starting to weaken," they also say.

On cost pressures, Kersley and team say the picture remains "problematic" with energy costs the top concern and labour costs intensifying since the last survey.

But there's also some better news.

Concerns over supply chain shortages have fallen significantly and the sense is that labour market tightness might be easing, which potential could be a major help to margins and also policymakers, CS says.

(Danilo Masoni)

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A NEUTRAL DOLLAR VIEW (1031 GMT)

The big deal for forex markets is whether the U.S. dollar will fall further after the recent significant decline from its 2-decade highs.

Some analysts recently sounded sceptical about a rebound as the Federal Reserve is thought to be close to the end of its rate-hiking cycle.

However, according to George Saravelos, global head of forex research at Deutsche Bank, the dollar is not ready to embark on a more sustained downtrend, at least for now.

"It is important to understand why the dollar has weakened so sharply in recent months: in our framework, it is all about the dollar's safe-haven risk premium," Saravelos says.

"China zero COVID, European energy and U.S. inflation/Fed hawkishness all drove a massive increase in the dollar risk premium throughout the year," he adds.

"Those three risks marked a definitive peak in November, in turn allowing for a sizeable USD turn."

"Bringing it all together, we are left with a neutral dollar view as the turn of the year approaches," Saravelos says.

(Stefano Rebaudo)

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STOXX DIPS, CHINA OPTIMISM NOT ENOUGH (0909 GMT)

China-exposed stocks from miners (.SXPP) to luxury and top FTSE gainer Prudential are seeing some demand this morning as traders play the reopening theme after reports of more easing of COVID-19 curbs in the world's No.2 economy.

Oil stocks (.SXEP) are up too, mildly, as the overall tone looks quite muted. Losses across most other sectors are more than offsetting the China-related optimism, sending the STOXX 600 SXXP regional benchmark falling 0.2% in early deals. The index is on track for a fifth straight day of declines, its longest losing streak in two months.

Lingering worries over an impending recession are clearly there behind the sombre mood. A warning over rising finance costs meanwhile hit BAT, even as the cigarette maker stuck to its guidance. The highly leveraged real estate sector (.SX86P) was off to a positive start but the move faded quickly .

Here's your opening snapshot:

(Danilo Masoni)

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EUROPE EYES TENTATIVE GAINS (0745 GMT)

European shares look set to open a touch higher this morning as investors assess risks related to a worsening macro outlook that has squeezed bond yields, tempered by expectations of a gradual reopening of China's economy.

EuroSTOXX50 FESX1!, DAX DAX1! and FTSE Z1! futures were last trading up 0.1-0.2% following gains in Asia on optimism over an easing of COVID restrictions in the world's No.2 economy. U.S. futures moved just above parity.

A number of share placements in Europe should liven up the session with traders betting on a rocky start for Vallourec, Vicore Pharma, Carmat and Nordic Unmanned after brokers launched share sales. Earnings releases are also on the menu.

An upbeat outlook look set drive UK packaging company DS Smith higher, and also the update from housing maintenance services provider Mears should be well received.

Eyes also on British American Tobacco, which forecast FY -year revenue growth of 2-4% as more people are using its e-cigarettes and oral nicotine products.

ASML is also in the spotlight after Bloomberg News reported Dutch officials are planning to enforce new controls on exports of chip-making equipment to China.

(Danilo Masoni)

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SO WHAT'S UP WITH TREASURIES? (0712 GMT)

Asking for a friend.

Because it is not often 10-year yields suddenly drop 11 basis points, break a chart big barrier and hit three-month lows for no discernible reason.

Some point a finger at the downward revision to Q3 U.S. labour costs. But Q3 is ancient history and only GDP nerds understand labour cost indices.

Yes, China trade data were truly awful, but both U.S November payrolls and the services ISM surprised on the high side and should be more meaningful for Treasuries.

True, the Bank of Canada did manage to be both hawkish and dovish by hiking 50bp but flagging it might be near done tightening. But the Fed is still going to hike 50bp next week and most analysts expect a higher set of FOMC dot plots for rates in part as a protest against recent financial market easing.

And what an easing it's been. Since the Fed hiked 75bp in November, 10-year yields have fallen 90bps to be 37 basis points under the cash rate, while 10-year fixed mortgage rates have dropped to 6.07% from 6.67%.

Of course, Fed Chair Powell caused much of this, given he had the perfect chance last week to push back hard against the easing and didn't - and it's still not clear why.

Maybe the sudden groundswell of recession fears has central bankers spooked. Treasuries are not innocent bystanders here, since the more inverted the curve becomes the more those fears seem justified.

There used to be a saying that the Treasury curve foretold five of the last two recessions, but these days nobody seems to doubt its pain-predicting powers. So long-term yields are tumbling because of recession fears caused by that very tumble?

Friend really wants to know.

Key developments that could influence markets on Thursday:

- China's health authorities will hold a press conference on COVID-19 prevention and control measures at 3 p.m. local time (0700 GMT).

- U.S. weekly jobless claims expected to rise back to 230,000, but tend to be volatile this time of year.

- Appearances by assorted central bankers from the ECB, Riksbank and Bank of Canada.

(Wayne Cole)

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