NEW YORK/LONDON – The U.S. government bond market sounded alarms Wednesday as investors fleeing riskier assets drove the 30-year bond’s yield to a record low and the 10-year yield fell below the rate on the two-year for the first time since 2007.
The 10-year Treasury yield dipped as much as 1.9 basis points below the two-year yield in what’s considered a harbinger of a U.S. economic recession beginning in the next 18 months. That expectation, nurtured in recent weeks by worsening U.S.-China trade relations and signs global growth is slowing, was bolstered Wednesday by weak Chinese and German economic data. The so-called inversion drew U.S. President Donald Trump’s ire, who tweeted Wednesday that Federal Reserve Chairman Jerome Powell is “clueless.”
Bad European and Chinese data were the trigger for the global bond rally, said Praveen Korapaty, chief global rates strategist at Goldman Sachs Group Inc. “From the pace of the move, I suspect some long-held steepeners are being unwound as well.”
Another widely watched recession indicator, the yield difference between three-month and 10-year Treasuries, inverted in March and has been negative much of the time since, bedeviling investors who anticipated that the yield curve would steepen as the Federal Reserve began to cut interest rates. The global bid for bonds also inverted the two-year to 10-year U.K. yield curve Wednesday.
“The bond market is saying central banks are behind the curve,” said Marc Ostwald, global strategist at ADM Investor Services in London. “It’s all doom and gloom on the global economy.”
Trump placed the blame for the “crazy inverted yield curve” squarely on the U.S. central bank, which he believes raised interest rates too quickly. The Fed’s reluctance to ease policy more aggressively is “holding us back,” he tweeted.
The inversion was brief as U.S. 10-year yields rebounded from as low as 1.57 percent to about 1.58 percent, while two-year yields shifted up to around 1.58 percent late in the U.S. day. Thirty-year yields at one point fell to a record low of 2.01 percent. In the U.K., 10-year yields dropped to 0.45 percent while two-year yields topped 0.48 percent even as inflation exceeded the Bank of England’s 2 percent target.
Yield curves normally slope upward as investors demand compensation for putting money at risk over longer periods of time. The willingness to accept lower yields on longer-dated assets than shorter-dated ones offer reflects the expectation that the longer-dated ones will produce higher returns over time as all yields decline, leaving holders of shorter-dated instruments to reinvest at lower rates when they mature.
The U.S. bond market has been a destination for haven flows given that there are fewer and fewer positive-yielding assets to park cash in globally, according to Richard Kelly, head of global strategy at Toronto-Dominion Bank. Roughly $15.8 trillion of global bonds have negative yields.
“The curve inversion to this point is flagging a 55-to-60 percent chance of a U.S. recession over the next 12 months,” Kelly said. “We can all debate whether those signals are as accurate as they once were, but we still seem to be in a slow grind lower for sentiment and momentum and need some positive surprises to change those trends.”
The curve isn’t the only thing flashing high alert. The Federal Reserve Bank of New York’s index showing the probability of a U.S. recession over the next 12 months is close to its highest level since the global financial crisis, at around 31 percent.
Others aren’t ready to sound the alarm yet. Former Fed chair Janet Yellen said Wednesday that the U.S. economy has enough strength to avoid a recession, but noted that the odds have “clearly risen.” She also said that the yield curve has become a “less good signal” of a U.S. downturn.
There’s little evidence in U.S. economic data to suggest a recession is imminent, according to Goldman’s Korapaty, who sees the 10-year yield returning to 1.75 percent by year-end. Independent strategist Marty Mitchell said the yield curve’s brief inversion is unlikely to materially sway traders’ behavior.
“Investors, portfolio managers, asset managers, hedge funds, and quants aren’t likely to change their market and economic thesis simply because the 2yr/10yr spread moves from +1bp to -1bp,” wrote Mitchell in a report Wednesday. “Yes, a more severe and prolonged inversion will cause them to make adjustments, but that’s not where we are today.”
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