The global bond markets have flashed an ominous signal for two of the world’s biggest economies amid mounting concern over a slowdown in growth and persistent uncertainty caused by the US-China trade dispute.
The spread of key interest rates in the United States and United Kingdom over different time horizons has inverted, with yields on longer-term debt falling below shorter-term bonds, moves often seen by investors as potential harbingers of economic downturns and recessions.
The bond market action ricocheted into equities on both sides of the Atlantic. Wall Street’s benchmark S&P 500 index tumbled 2.3 per cent, while London’s FTSE 100 was 1.4 per cent lower. The pan-European Stoxx 600 gauge shed 1.5 per cent. In Dublin, the Iseq fell by 1.8 per cent.
US 10-year treasury yields dropped 1 basis point (0.01 percentage point) below that of the two-year, according to Tradeweb data. It marked the first time this has occurred since the lead-up to the 2008-09 recession.
A different part of the treasury curve that compares three-month yields against 10-year yields had already inverted, but the shift in this area is the latest indication of growing unease in the fixed income market.
Typically longer-term debt trades with higher yields to compensate investors for the risk of holding debt for a longer time during which it is more difficult to predict economic conditions. When the yield curve flips, it is generally seen as a strong signal that investors are expecting an economic downturn.
"This is a warning sign about the global slowdown," said Andrea Iannelli, investment director at Fidelity International. "There's a lot priced in terms of bad news, but for now the momentum remains extremely strong."
Quincy Krosby, chief market strategist for Prudential Financial, said: "The two-year and 10-year inversion is very important – you dismiss this at your peril.
“Many who said the three-month and 10-year inversion was not a viable warning sign were waiting for the two-year to invert – now it’s here.”
In a further bearish sign, the UK two- and 10-year curves also inverted on Wednesday for the first time since 2008. Inflation data released on Wednesday showed consumer prices were climbing at a faster pace than the Bank of England’s target with Brexit looming just months away. Economists said it underscored the difficult position for policymakers, with rising inflation suggesting an interest rate increase might be necessary, but signs of an economic slowdown pointing to the opposite.
Geoffrey Yu, head of the UK investment office at UBS Wealth Management, said: "The latest data presents a further headache for the Bank of England, who will need to weigh up their next policy move in the context of both rising inflation and weak economic growth."
Mike Riddell, a bond portfolio manager at Allianz Global Investors, cautioned that the UK yield curve was a less reliable recession indicator than its US counterpart. "The UK curve spent almost half the 1990s inverted and things were fine," he said.
Still, he said, there was “no question that a curve that is flattening or inverting is increasing the chances of recession”.
Disappointing data on China’s sprawling industrial sector and a report showing that Germany’s economy contracted in the second quarter both set a gloomy tone across global trading desks on Wednesday. It added further evidence to the notion that the US-China trade war has had a meaningful effect on the world economy.
“The recent escalation in US-China tensions reinforces our view that trade and geopolitical frictions have become the key driver of the global economy and markets,” BlackRock, the world’s biggest asset manager, said earlier this week. – Copyright The Financial Times Limited 2019