Yield curve inverts after hawkish Fed remarks
Shorter-dated Treasury yields once again eclipsed those for longer-dated notes on Thursday, signalling fears among bond market investors that the Federal Reserve will fail to cut its benchmark rate fast enough to shield the US economy from slowing global growth and an escalating trade dispute with China.
For the third time this month, the yield on two-year US Treasury bills jumped above that of the benchmark 10-year note. Another portion of the yield curve — reflecting the difference between the yields on three-month and 10-year Treasury securities — slipped deeper into negative territory, settling just shy of 40 basis points.
The inversion of the yield curve — which has occurred before every US recession of the past 50 years — came as Fed officials convened in Jackson Hole, Wyoming, for their annual meeting, to be capped off with a speech by Jay Powell, Fed chairman.
Less-than-dovish commentary from Esther George, the Kansas City Fed president, and Patrick Harker, the Philadelphia Fed president, fuelled concerns that the central bank was unlikely to meet market expectations and slash interest rates roughly 100bp by the end of 2020, as futures prices currently indicate.
In television interviews, both Ms George and Mr Harker said they saw little reason for additional interest rate cuts beyond the Fed’s quarter-point reduction in July.
Ms George, who had voted against the rate cut, told Bloomberg: “As I look at where the economy is, it’s not yet time, I’m not ready, to provide more accommodation to the economy without seeing an outlook that suggests the economy is getting weaker.” Mr Harker said on CNBC that more accommodation “wasn’t required”.
John Briggs, the head of strategy for the Americas at NatWest Markets, said: “They are almost waiting until it is too late, and that is what the curve is reflecting.”
Tom di Galoma, a managing director at Seaport Global Holdings, said the Fed’s approach so far amounts to “dragging its feet” at a time when in his roughly 30 years in the business he has “never seen the market looking for Fed cuts this extensively”.
“If you look at the total picture, there is some credibility to the fact that they should be doing more rather than less,” Mr di Galoma added, citing evidence that an inverted yield curve is a precursor for a recession 12-15 months from now.
US factory activity contracted this month for the first time since September 2009, according to IHS Markit’s US manufacturing purchasing managers’ index. On the inflation front, the 10-year break-even rate, derived from prices of inflation-protected government securities, slipped to the lowest level in three years at 1.54 per cent.
Given the economic backdrop and the escalation of the US-China trade war, Mr di Galoma said he anticipated a “major shift” at Jackson Hole in which Mr Powell “changes his tune to a more dovish tone”.
Subadra Rajappa, head of US rates strategy at Société Générale, said she was watching whether Mr Powell would continue to characterise any future easing as a “mid-cycle adjustment” as he did in July, disappointing investors who were anticipating a more prolonged easing cycle.
Framing the central bank’s monetary policy approach the same way would “indicate that they won’t be aggressive or cut a lot . . . which would be at odds with what the market is pricing,” she said.
Seema Shah, a strategist at Principal Global Investors, said Mr Powell “needs to get the message right” at Jackson Hole, given market expectations and his bungled communication efforts in the past.
“We’re getting to a point where sentiment is so precariously balanced that you need a circuit breaker,” she added. “If the Fed does not indicate further easing to come, then markets are going to think the Fed is no longer there to support them and it will contribute to a downward spiral.”