The Federal Reserve’s decision to keep rates unchanged earlier this month is stirring concerns that a US recession might be just around the corner amid international trade tensions, an inverting yield curve, and a cooling manufacturing sector.
Kristian Rouz — Recent developments in the US bond market are stirring concerns of a possible recession among economists and market participants. Experts warn that an inverted yield curve, where the profitability of 10-year US Treasury bonds is lower than that of three-month US Treasury bills, might encourage investor demand for safer assets, pulling capital away from the non-financial sector.
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According to US fixed-income market data from Bloomberg, the yield on US 10-year T-bonds dropped 1.9 percent below the three-month T-bill yield — meaning longer-maturity bonds now have more investment appeal than short-term instruments.
The inversion of the Treasury yield curve has deepened since the latest meeting of the Federal Reserve earlier this month, during which policymakers left interest rates unchanged and took a softer, more cautious stance on monetary policy.
“The risk of a US recession has risen and is flashing amber and this will keep markets pricing a high chance of the Fed cutting rates,” Tapas Strickland of National Australia Bank (NAB) in London said.
Bloomberg data also suggests that the 10-year yield is now at its lowest since the first quarter of 2018, while inversion of the yield curve is at its deepest since 2007, as of last Friday. In the past, an inverted yield curve has been a clear indicator of an upcoming economic downturn — as it reflects a nascent disinvestment trend in the Main Street economy.
However, Fed officials pointed out that US business investment is on the rise, particularly, capital expenditures (capex) — which suggests the current expansionary cycle will likely continue for at least several quarters.
Despite the alarming reports, some analysts are not convinced the US is facing an imminent recession threat at this point.
“We suspect that drawing a recession conclusion from such data is not warranted until the 3M-10Y yield curve is inverted by a substantial amount,” Rob Carnell of the Dutch bank ING Group said. “Just inverted, as today’s markets indicate, doesn’t do it for me.”
However, many market participants are sceptical, saying recent dynamics in the bond market suggest US stocks aren’t a good buy at this point.
“The bond market price action is an enormous blaring siren to anyone trying to be optimistic on stocks,” analysts from the US investment bank JP Morgan wrote in a note. “Growth, and bonds/yield curves, will be the only thing stocks should be focused on going forward and it’s very hard to envision any type of rally until economic confidence stabilizes and bonds reverse.”
The drop in equity markets worldwide that followed the alarming reports of a US yield curve inversion, also weighed on international oil prices. A US recession would mean lower demand for oil globally, as other countries would likely also be affected in the form of a slowdown in the manufacturing, utilities, and energy sectors.
Separately, last week’s report from the US government found US manufacturing activity has slowed this month.
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Brent crude was down 0.7 percent to $66.56/bbl on Monday, while US oil dropped 0.9 percent to $58.52 overnight amid recession fears.
“Estimates for growth and earnings have been revised down materially across all major regions,” experts from the US bank Morgan Stanley wrote.
However, a heightened demand for safe-haven assets — including longer-term bonds — also spurred demand for gold. Bullion went up in price more than 1 percent over the past week, following the Fed’s report. Spot gold rose to $1,316.40/oz. in London.
Gold prices have been on the rise for the past three weeks as several major economies, most prominently, the Eurozone, have posted disappointing business activity reports and GDP projections, while the lingering threat of a global trade war hasn’t added to the fading appetite for riskier assets.
“The market is in a risk aversion mode. It seems that the data from Friday night, of US and Europe, didn’t come as expected,” Michael McCarthy of CMC Markets said.
In this light, analysts expect gold to extend gains toward $1,350/oz., while volatility in the stock market is set to increase as well.