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- The Household Finance Curve, or spread between future and current finances, per UMich, was negative in both April and May; these readings are significant outliers, since negative prints have happened just 6% of the time in UMich data going back to 1978
- Since 1987, the Household Finance Curve has provided guidance for the 5s30s nominal yield curve; however, April and May’s declines of 2 and 7 points occurred against 5s30s readings of 146 and 154 basis points, respectively, record divergences that suggest a correction is due
- The relationship between the 5s30s curve and S&P 500 Financials Index has tightened since 2017, with a flatter inflation curve signaling stronger performance; a turn in the 5s30s curve from its current inversion could pull the S&P 500 Financials off its May-end record high
The Memorial Day holiday in the United States marks the unofficial start to summer. Racing fans need no reminding the long weekend is nigh; they key off that other major event. The Indianapolis 500 has taken place at the Indianapolis Motor Speedway (IMS) over Memorial Day weekend for more than one hundred years, save two even more patriotic exceptions — World War One (1917-1918) and World War Two (1942-1945). The first green flag was waved on May 30, 1911; Ray Harroun in his Marmon Wasp racing car took the checkered flag. After having to ban spectators last year, 135,000 fans, roughly 40% of capacity, were permitted to take in the riveting spectacle this year. Lucky attendees of the 105th running witnessed history as Helio Castroneves took home his fourth Indy 500 victory, joining three other legendary drivers — A.J. Foyt, Al Unser and Rick Mears – who’ve accomplished that same feat.
Veterans of the Brickyard, so named after the racecourse first opened in 1909, when the track surface was crushed stone and tar, know that the two-and-a-half-mile rectangular oval is the essence of symmetry — two long and two short straightaways of five-eighths of a mile and one-eighth of a mile, respectively. The four curves clock in at an even quarter mile each, and the banking in every corner measures nine degrees, twelve minutes.
Observable curves in financial markets are rarely symmetrical. Forward curves are constantly changing and repricing while yield curves are perpetually flattening or steepening. This year, inflation curves are all the rage. We all know why.
But there are also macro curves, which regular readers know we follow closely. We define the Labor Curve as the difference between current and future employment conditions. Meanwhile, the Economy Curve pits current and future business conditions against one other. Today, we introduce the Household Finance Curve.
The University of Michigan consumer survey asks two key questions to create its headline Sentiment index. The first enquires about households’ current personal finances and the second about their future money situation. The spread between the latter and the former creates our Household Finance Curve.
A steeper curve implies better earnings prospects; a flatter curve suggests compression between the two series; while an inversion occurs when future finances fall below that of present. Over the entire monthly history since 1978, inversions have happened just 6% of the time. Call it a 94th percentile left tail. That makes the April 2021 and May 2021 readings significant outliers.
The Household Finance Curve has provided accurate guidance for the U.S. Treasury five-year/thirty-year (5s30s) nominal yield curve since Alan Greenspan chaired the Federal Reserve in 1987. A steeper (flatter) finance curve was followed by a steeper (flatter) yield curve. The finance curve inversions this April (-2 points) and in May (-7 points) occurred against readings for the 5s30s curve of 146 and 154 basis points (bps), respectively. Both months registered record divergence between both curves. In our book, something has to give to correct for one of the two possibly emitting an inaccurate signal.
Before jumping to conclusions, let’s throw a curve ball and look at another curve, the 5s30s inflation curve. The left chart explains. The 5s30s inflation curve (red line) is the spread between thirty-year and five-year inflation breakevens, or the difference between nominal and real yields at the respective tenors. The constant-maturity 5s30s inflation curve dates from 2010. Since that starting point, the inflation curve has tracked and more recently led the movement in the Household Finance Curve (blue line).
It’s as if inflation traders have sniffed out challenges to households’ future finances. This also was picked up by Richard Curtin, long standing director of the University of Michigan consumer survey. He noted that household “financial prospects for the year ahead declined to the lowest level in seven years, with the falloff mainly among those over 45 and in the bottom two-thirds of the income distribution. Year-ahead expected income increases fell to 1.6% from 1.8% in April, with expected declines in inflation-adjusted incomes voiced by a five-year high 43%.”
To Curtin’s last point, most consumers believe that in five years, prices will increase faster than their incomes do over the next year. Know this, when households are asked about the outlook for their personal finance, the answers are “better off”, “worse off”, “same”, or “don’t know”. These choices could be influenced by more than just expectations about how quickly or slowly their paychecks will expand. Higher prices clearly would make consumers worse off.
The inversion in the 5s30s inflation curve is beginning to stabilize, indicating a potential inflection point. Should this be the case and short-run inflation expectations start falling relative to long-run inflation expectations, the finance curve could reinvert back into positive territory.
The inflation curve guides more than just household finances, it gauges financial sector stocks as well. The right chart depicts the 5s30s inflation curve again, but this time against the inverted S&P 500 Financials index. Since 2017, the relationship between these two series has tightened – a flatter inflation curve signaled strengthening while a steepening flagged underperformance.
The latest inflation curve inversion paralleled a May-end record high S&P Financials index. A turn in the inflation curve would communicate “Sell Fins.” Indy car drivers have a relatively easy go of it navigating four of the same curves at the IMS. Investors should only be so lucky.