Wednesday, 19 December, 2018

Why the Yield Curve Inverts in One Simple Picture - Mish Talk

US dollar falls on economic growth fears Global stocks dive on growth concerns, doubts over trade truce
Nellie Chapman | 07 December, 2018, 19:11

"The market decline in the US overnight and the flattening of the yield curve reflect that economic growth momentum is taking over as the primary concern for investors, even as the latest ISM manufacturing data is holding up well", wrote Tai Hui, market strategist at J.P. Morgan Asset Management.

"The market implied path of policy rates still suggests a greater likelihood than not of a rate increase at the December meeting, but compared to what was priced in at the end of September, there seems to be a belief that we are less likely to have seen as many increases by Q3 next year".

Such an inversion of two-year and 10-year yields, when 10-year bonds yield less than their two-year debt, has preceded every USA recession in the past 50 years.

Typically, bonds with longer maturities offer higher yields, as investors demand greater compensation to keep their money locked away for longer time periods.

A typical yield curve includes much higher interest rates for maturities further into the future.

For the most comprehensive local coverage, subscribe today.

Usually it's the other way around, and it means investors are anxious about the short-term health of the economy.

Global equities have been shaken as a flattening U.S. Treasury yield curve fans worries about a recession, and on growing doubts that Washington and Beijing will be able to clinch a substantive trade deal during a temporary cease-fire agreed at the weekend.

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 Australian dollar, viewed as a barometer of Chinese growth, gave up early gains to trade 0.26 percent lower.

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. This is seen as a portent of a US recession.

"If that is indeed to be the case, the recent strong equity recovery is at risk from fundamental economic deterioration, a message that is sounding from the junk bond market, whose rebound has been far less impressive".

"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. The Big One will be when 2-year and 10-year Treasury rates swap places, and bond traders are doing their darnedest to make it happen soon, as Robert Burgess points out. An inversion of the yield curve has preceded past recessions.

The pound rose off 17-month lows of $1.2659 hit on Tuesday to around $1.2780, up 0.3 percent on the day, amid creeping optimism that Britain could opt to stay in the European Union after all.

Of course, that's still "pretty doggone tight", said Randy Frederick, vice president of trading and derivatives at Charles Schwab.

Hong Kong's Hang Seng retreated 1.55 percent and the Shanghai Composite Index dipped 0.2 percent. A separate spread between 3-month and 10-year Treasury securities, considered by some as a better recession predictor, was also falling, though at just around 0.5 percentage point it remained comfortably in positive territory.

Even if the more important parts of the yield curve flip to inversion, that doesn't mean a recession will happen the next day.