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Recession or not, the currency markets does fine

The currency markets keeps chugging higher despite growing evidence that the economy is in deepening trouble.

Driving the news headlines: The S&P 500 posted just one more gain Thursday, even with new data showed the economy shrank for a second straight quarter.

  • The index is up a lot more than 7% up to now in July, enjoying its best month since November 2020, when positive news about the potency of COVID-19 vaccines first emerged.

The intrigue: Needless to say, stocks rallying on the arrival of vaccines appears to make intuitive sense. (It portended a recovery from an ugly economic and public health crisis.) Could it be logical, then, for stocks to rally on the chance of recession?

The solution: Yes! Around here, we often say “the currency markets isn’t the economy (TSMINTE for short).”

  • It’s our shorthand to remind you that despite decades of press coverage that conflates fiscal conditions and currency markets performance, the marketplace actually did quite nicely during downturns. This is also true once the Federal Reserve cuts interest levels.
  • Just consider the anni horribili of 2020 and 2021. Thousands of dead. An incredible number of jobs lost. The sharpest downturn on record. Well, during those dark years the S&P 500 rose 50% as Fed easing pumped trillions into markets.

State of play: Flash forward to the year. It had been the Fed’s relatively rapid move against surging inflation hiking rates and pulling back on money printing that crushed the currency markets, sending the S&P 500 down nearly 24% as recently as mid-June.

  • Since that time the currency markets is up a lot more than 11%. What’s changed?

Underneath line: Interest levels tell the story.

  • Starting in mid-June, the yield on the 10-year Treasury note probably the most widely followed bond gauge, has plunged from about 3.50% to about 2.70%. (As we’ve explained before, falling interest levels almost automatically push share prices higher by raising market valuations.)
  • Rates decrease when expectations about growth and inflation fall. So, in ways, that it is the fears of the slowdown which are assisting to drive share prices up.
  • Weird but true. And totally in keeping with TSMINTE.

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