Stocks battered by Wall Street, fears of USA slowdown

Cornelia Mascio
Dicembre 7, 2018

This yield curve inversion is often a sign of an imminent economic recession, so here's a look at what the latest bond market developments mean for investors.

Jeffrey Gundlach, chief executive officer of DoubleLine Capital, said the U.S. Treasury yield curve inversion on short-end maturities was signaling the "economy is poised to weaken".

In an "economic letter" published by the San Francisco office of the U.S. Federal Reserve (Fed), Michael D. Bauer and Thomas M. Mertens summarize the implications of an inversion succinctly: "Every U.S. recession in the past 60 years was preceded by a negative term spread, that is, an inverted yield curve".

Weakening global growth, trade-war fears, higher interest rates, and wariness over the extent of Federal Reserve tightening are weighing on markets.

When yields for short-term Treasurys rise above yields for long-term ones, market watchers call it an "inverted yield curve", and Wall Street starts getting more nervous.

The benchmark Treasury 10-year yield fell to its lowest point since mid-September on Tuesday, while the spread between the 10-year yield over its two-year counterpart also shrank to the smallest since the start of the financial crisis in January 2008.

The closely watched spread between two-year and 10-year bonds dipped below 0.1 percentage point on Tuesday, the lowest since before the last recession and continuing a slide that began in October.

No, at least not yet.

President Donald Trump has been railing against the Fed's ongoing policy of gradually raising interest rates, complaining that it's slowing USA economic growth. "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", Gundlach added.

Market watchers also say they won't get anxious until a more important part of the yield curve flips.

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.

Yield-curve inversions typically occur months - or even years - before a recession. Of course, that's still "pretty doggone tight", said Randy Frederick, vice president of trading and derivatives at Charles Schwab.

The greenback rose 0.32 percent against the Japanese yen and the euro gave up all its early gains to trade down 0.04 percent against the dollar.

Italian bonds extended their rally, with two-year yields falling 10 bps to 4 1/2-month lows IT2YT=RR after a cabinet official raised hopes that the government could cut almost four billion euros from its 2019 budget plans.

"It could be many months before we see that point of the curve invert", he said in a research note to clients.

What exactly is a yield curve, and why is it inverting? There have also been false positives in the past, where the yield curve has inverted but no recession has followed, such as in 1966.

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