US yield curve signals optimism for 2020

Indicator that once warned of recession now at its steepest in more than a year.

  • By Colby Smith,
  • Financial Times
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A US bond market indicator which signalled earlier this year that a recession could be imminent is closing 2019 at its most optimistic in more than a year, suggesting that the Federal Reserve has successfully steered the economy through a global growth scare.

The US yield curve, which shows the difference between short-term and long-term interest rates and is one of the most closely watched barometers of market confidence, on Monday reached its steepest level since October 2018.

The new 2019 record was set by bond traders even as equity market investors took profits from a rally that has propelled global stocks to their best year in a decade. Government bonds in Germany and the US, refuges for investors in more risk-averse times, both sold off on Monday.

Peter Boockvar, chief investment officer at Bleakley Advisory Group, said equity markets are already expecting a benign 2020 for the global economy, after the US Federal Reserve cut rates three times this year and Washington and Beijing appeared close to signing the truce they have agreed in their trade war.

“If the stock market is right that everything is amazing, I don’t see how long rates can stay as low as they are,” he said. “The stock market is rallying on hope. Hope that things will inflect higher with this trade deal and Fed accommodation.”

For two weeks in August, the US yield curve inverted, meaning short-term yields were higher than longer-term ones. Investors paid close attention to the move because an inversion has occurred before every US recession of the past 50 years.

At its worst, the difference between the yields on two-year and 10-year Treasuries was minus-5 basis points. On Monday, the gap was back to 33bp, as the yield on the 10-year Treasury rose 4bp to 1.91 per cent while the two-year yield was flat.

Earlier in the day, the yield on Germany’s benchmark 10-year bond was up 7 basis points to minus-0.19 per cent, the least negative level since May. In Japan, the 10-year government bond yield hovered near its highest level in roughly eight months. Central banks have been reconsidering the effectiveness of negative rates to stimulate growth, contributing to the increase in yields.

The FTSE All World index, which measures the global equity market, is up 24 per cent since the start of 2019, better than any year since 2009 when the market was recovering from the financial crisis.

While US equities slipped slightly on Monday, the S&P 500 (.SPX) minted three fresh record highs in the previous week and is now up almost 29 per cent this year. President Donald Trump has touted the stock market rally as he gears up for his re-election campaign next year, though Democratic rivals say the gains are not being felt by most Americans.

After three rate cuts designed to deal with uncertainty over the global economy, including any effects from Mr Trump’s trade wars, the Fed indicated earlier this month that it will put on pause any additional monetary policy tweaks until either inflation picks back up significantly or it can see a material slowdown in the economic data.

In mid-December, the US and China reached a deal to cut certain tariffs and delay planned new levies in a bid to de-escalate the trade war. The South China Morning Post reported on Monday that what is being called a “phase one” trade deal between the countries could be signed in Washington as early as this week.

“We’re out of the doldrums,” said Mike Mullaney, director of global markets research for Boston Partners, an asset manager. “Leading economic indicators are starting to improve.”

Mr Boockvar warned that the steepening in the US yield curve could prove to be shortlived, however.

“People who are expecting a bottom in growth with the trade deal are misplaced because we are still stuck with most of the tariffs,” he said. “At best, growth in the US will be around 2 per cent in 2020. Europe will not grow more than 1 per cent and China is still slowing down.”

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