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 battle.
The spread of key interest rates in the US and UK over different time horizons has inverted with yields on longer-term debt falling below shorter-term bonds, a move often seen by investors in the past as potential harbingers of economic downturns and recessions.
America’s 10-year Treasury yield dropped 1 basis point (0.01 percentage point) below that of the 2-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 yields curve flips it is generally seen as a strong signal that investors are expecting an economic downturn on the horizon.
In a further bearish sign, the UK 2-and-10 curve 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 a rate increase might be necessary, but signs of an economic slowdown suggesting 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 is 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 is “no question that a curve that is flattening or inverting is increasing the chances of recession.”
The move on Wednesday came amid a fresh shift by investors away from risky assets and into perceived havens, like government debt. The pan-European Stoxx 600 stock index was down 0.9 per cent with S&P 500 futures declining by roughly the same margin less than three hours ahead of the opening bell.
Disappointing data on China’s sprawling industrial sector and a report showing 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 debacle 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.
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