Economy

Yield curve inversion revives concerns over economic slowdown

Yield curve inversion revives concerns over economic slowdown

The bond market just flashed a big warning sign for the economy. A hint at rate cuts coming down the pipeline would offer much needed breathing room for emerging market (EM) currencies and move funds from USA government bonds to other havens of interest returns causing them to appreciate against the dollar.

Markets across the world have been rattled by recession fears, exemplified by the flattening U.S. Treasury yield curve.

Weakening global growth, trade-war fears, higher interest rates, and wariness over the extent of Federal Reserve tightening are weighing on markets. One portfolio manager called the inverted yield curve a "harbinger of doom".

On Monday, 2- and 5-year Treasury yields inverted, meaning the shorter dated 2-year money became more expensive than the later maturing 5-year. The 10-year Treasury note yield fell about 6 basis points to 2.498% on Tuesday, its lowest since September 13, while the spread between two- and 10-year notes dropped to 0.14%, the flattest level since June 2007, setting the tone for a possible inversion of spreads in the future.

The yield curve inverted between the two- and 10-year yield before the recessions of 1981, 1991, 2000, and 2008.

No, at least not yet.

Whatever the situation with the Fed and the US markets, emerging markets may be effected even more than the USA economy.

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"In the initial phase of the inversion of the yield curve markets are anxious and react more aggressively to weak data than to strong data", said Masafumi Yamamoto, chief currency strategist at Mizuho Securities.

"This solidifies not only my flattening bias but I think it will lead many players in the market who [expected the yield curve to steepen] to capitulate on that", Ian Lyngen, head of united rates strategy at BMO Capital Markets, told CNBC. An inversion between 3-month Treasury bills and 10-year Treasury notes is viewed as a "more appropriate indicator" of a recession.

"Investors are coming around to our downbeat view of the prospects for the USA economy", analysts at Capital Economics wrote on Tuesday, arguing that there was no reason to regard this pending yield curve inversion as different from others. Of course, that's still "pretty doggone tight", said Randy Frederick, vice president of trading and derivatives at Charles Schwab. The euro was 0.11 percent lower.

Lyngen said the inversion of three- and five-year yields had increased the likelihood that an inversion of the two- and 10-year yield would happen by early 2019.

"Inversion of that curve is the real recession red flag", said Neil Wilson, the chief market analyst at Markets.com. Even if the more important parts of the yield curve flip to inversion, that doesn't mean a recession will happen the next day. "If twos and 10s invert between now and December 18, the Fed is going to have to take out some of the hikes next year, or they should do it", said Joseph Lavorgna, chief economist of the Americas at Natixis.

The yield curve shows the returns on bonds of different maturities, from a few months on the so-called short end to as long as 100 years on some corporate bonds.


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