Every investor seems to be panicking about the yield curve right now, and not without reason. An inverted yield curve has accurately predicted each of the last several recessions. And not only is the yield curve inverted, but yields are shockingly low—the 30-year Treasury yield just went sub-2% for the first time ever. However, that is not what you should be worried about, argues a top economist at the Economic Outlook Group. Instead, you should be watching consumers like a hawk, as they will be the deciding factor as to whether the US heads into a recession. “All eyes should therefore be laser focused on what households are thinking and doing in the coming months--- and not on some tampered yield curve”, says Bernard Baumohl, chief global economist at the Economic Outlook group.
FINSUM: The yield curve is less manipulated than it once was, but we are far from a rate environment one could say was comparable to inversions past. We think this analysis is spot on.
Yields are really low, right? No! In fact, they are high. That is how investors may need to start thinking about yields. Everything we thought we knew from the last 50 years might be worthless now. The CIO of Northern Trust explains “I continue to be surprised by my fellow asset management professionals who think that the long-term norm for the 10-year U.S. Treasury should be closer to 4% or even 4.5% … This is just too high when you consider among other facts that there is $15 trillion invested the bond markets globally right now that is carrying a negative interest rate”. He continued “On the day of this discussion the Swiss 10-year is at negative 90 basis points, the German 10-year is trading at negative 56 basis points, and the Japanese 10-year is at minus 20 basis points … So, why would the U.S. 10-year trading at close to 1.5% or 1.75% seem low? It’s in fact unusually high in the global context”.
FINSUM: Maybe super “low” yields are the new normal, and we should think of the US’ yield level as abnormally high right now. It is hard to stomach and has enormous implications, but it may very well be the truth.
The yield curve is sending increasing warnings that a recession is coming. While the three-month and ten-year yield has been inverted for months, a new inversion occurred yesterday, when the ten-year yield moved below the two-year yield. Even more eye-opening was that the 30-year bond yield fell to just 2.06%. That figure shows that investors have abandoned all fear of rising rates and all economic bullishness.
FINSUM: We don’t know whether to be more worried about a big correction in bonds, or that the economy may actually be as bad as bonds are suggesting! Either way things look bad.
The US’ leading bond manager has just made a bold call. Pimco thinks that US bond yields will follow Europe and go negative. Speaking about the market situation more broadly, Pimco says “The next several years could be the exact opposite of what we saw in the past five to 10 years … That was high returns on financial assets and low volatility. That will be turned upside down”. Pimco is particularly concerned about a recession, believing it would send yields sharply lower. However, that is no sure bet, because if the trade war gets sorted out sooner than expected, yields would likely move higher quickly.
FINSUM: Yields moving lower seems to be the path of least resistance, so we think that is the direction that bonds will trend.
One of the world’s most respected financial columnists—John Authers—has just put out an article arguing that we may be at the bond market’s Dotcom moment. Authers cites the gigantic hoard of negative yielding debt, as well as many charts of soaring 100-year bond prices (check out Austria’s and Mexico’s), to show that the bond melt up may be set to reverse. He argues that at some point soon (it could have already started with the reversal in ten-years yesterday) that investors will revolt against super-low yields, sending prices lower and yields higher. Authers thinks the spark may be unexpectedly higher inflation, which would undermine the whole premise of recent gains. Tariffs are inflationary by definition, so it is not far-fetched to think this could occur.
FINSUM: We think it would take a significant catalyst to cause a big bond pullback (like a much higher than expected inflation report, a suddenly hawkish Fed etc). That is not out of the question, but it does not seem likely.
The big market ruction of the last few days has sent the yield curve inversion to very worrying levels. The spread between three-month bills and ten-year Treasuries has widened to minus 32 basis points. A yield curve inversion has preceded every recession for the last 50 years. “The US has been an island of prosperity in a sea of weakness, but that looks to be ending as the impact on the consumer side from the new tariffs is likely to be bigger than the previous ones”, said a senior portfolio manager at PGIM fixed income.
FINSUM: The last time the yield curve was this inverted was April 2007. That fact alone is major warning sign.