Bonds signal growing global distress as key yield curve flips
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 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.
"Bad European and Chinese data today are 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."
The inversion was brief as U.S. 10-year yields rebounded to about 1.6%, two-year yields to about 1.58%. Thirty-year yields fell to a record low of 2.01% before stabilizing around 2.05%. In the U.K., 10-year yields dropped to 0.45% while two-year yields topped 0.48% even as inflation exceeded the Bank of England's 2% 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%.
Others aren't ready to sound the alarm yet. 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% 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."