US yield curve sends most dire signal since 2007

US yield curve sends most dire signal since 2007

A widely watched US bond market indicator of recession sent its most dire signal since the early days of the financial crisis on Tuesday, reflecting increasing gloom about the economic consequences of the US-China trade war.

Yields on two-year Treasury notes were 5.3 basis points higher than those on the 10-year government bond — the largest gap since March 2007. This kind of inversion of the yield curve — in which shorter-term rates are higher than longer-term ones — has preceded every US recession of the past half century.

At the same time, another closely followed portion of the yield curve — reflecting the difference between the yields on three-month and 10-year Treasury securities — blew past its recent lows, settling at minus 51.4bp.

“It’s the ultimate flashing red light,” said Tom di Galoma, a managing director at Seaport Global Holdings, who forecasts a recession within 12 to 18 months. “What is taking place today is that bond investors are realising that lower rates are upon us.”

The growing inversion of the yield curve reflected investor scepticism that Donald Trump’s more conciliatory rhetoric in recent days would lead to a swift resolution of the trade dispute between Washington and Beijing, analysts said.

The US president on Friday said he would increase tariffs on Chinese goods after Beijing said it was preparing to slap new levies on $75bn of US imports.

Market expectations for the Federal Reserve to cut interest rates have risen in recent weeks. According to futures prices compiled by Bloomberg, traders are pricing in a 91 per cent chance the central bank will cut rates by a quarter-point in September. They see a 9 per cent chance the Fed will move ahead with a more aggressive half-point cut.

Should the Fed not ease accordingly at its next meeting, some investors warned that the inversion of the yield curve could become even more extreme.

“At the minimum, it tells you the market believes Fed policy is too tight,” said Kathy Jones, the chief fixed-income strategist at Charles Schwab. Moreover, she added, the risk of recession are “rising and it’s something we need to be cognisant of”.

Germany is already on the brink of a recession, according to the central bank in Europe’s largest economy, while Goldman Sachs recently slashed its growth forecasts for the so-called “Asian Tigers” — Hong Kong, Singapore, South Korea and Taiwan — given their exposure to a trade-related slowdown.

The planned tariffs by Mr Trump could push the US economy along a similar path, according to analysts at Bank of America Merrill Lynch, given that China is the dominant supplier for most of the goods set to be hit with tariffs later this year

Economists also have been worried by recent US data, despite measures of consumer confidence being rosier than expected and the labour market remaining robust.

While the headline figure of durable goods orders came in above expectations this week, Lydia Boussour, the senior US economist at Oxford Economics, said, “The underlying trend remains firmly negative.”

When a 44 per cent surge in aircraft and parts was stripped out, core capital goods orders fell 0.3 per cent on a year-over-year basis — the slowest pace since November 2016.

The data came less than a week after a gauge of US manufacturing activity contracted for the first time since 2009.

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