Bond markets are telling us all we need to know

Thursday, 15th August 2019 13:49 - by Shant

The last few weeks and months have been testing times for the equity markets, pushed and pulled to the tune of the mood in the trade between the US and China.  After the announcement of fresh tariffs, it is clear to many that a workable and sustainable trade deal is some way off and in terms of placating the respective real economy - on all sides - the most recent developments of a delay bearly register as a sticking plaster to the underlying wounds caused by this ongoing trade standoff.  Some are viewing the latest concessions from the White House as a sign of weakness on the US part.  Even so, it is hard to see further ground being conceded at a time when the US president is trying to strengthen is political gravitas going into an election year in 2020.

While equity markets continue to hang their hopes of an eventual resolution, the bond markets are reflecting a much different picture, and it is hard to avoid the flurry of red flags reported by ardent observers of the yield curve.  The spate of inversions on various parts of the Treasury curve has finally spread to the 30yr, where we have finally seen yields dipping below 2.00% - now just over 25bps below current Fed Funds.  

However, the traditional recession indicator is the 2yr vs 10yr spread, with has been flirting with parity over recent sessions, though we did see a brief inversion yesterday morning of close to 2bps, back now to 2bps 10yr over.  Even so, these marginal moves do not mask the wholesale rush into Fixed Income - moves which have seen the German 10yr pushing out -67bps on Wednesday morning.  The bulk of negative-yielding bonds come from Japan (no surprise) and Europe, where the French 10yr yields are now close to -40bps.  With some decent Japanese figures coming out this week and suggesting some possible upside pressure in inflation levels, JGBs at -23bps are suddenly looking attractive too!

However, considering the broader market where Gold prices have surged through the $1500 - and are set to go higher still - there looks to be a clear divergence from US equity prices, which as yet, seem to be carrying some safe-haven qualities if fund manager sentiment is to be considered.  On this basis, we can assume that there is still a sense of immunity (perceived or otherwise) in the US economy and that the global slowdown will continue to bypass that of the US.  Well, the domestic PMIs are begging to differ and as already noted, the bond markets are clearly taking note.

Whether or not the gradient of the Treasury curve is a precursor to a US recession or not - and this may take anything from a year to 3 years to materialise - the flight to safety will impact on Wall Street at some point, and especially so with a US Dollar which refuses to give up any ground.  Investors will be hoping for the Fed to come to the rescue and make policy adjustments with a little more clout than we saw at the start of August.  Suddenly, a 50bp cut does not seem so extreme - even if the bond markets are effectively 'insisting' on it.

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.