Bond market sounds alarm as Treasury yield curve inverts
Investors are about to absorb US$131 billion of Treasury note auctions at the lowest yields in months, after they piled into U.S. debt following a dovish Federal Reserve decision and fresh signs that global growth is weakening.
The week kicks off with a closely watched segment of the U.S. yield curve foreshadowing a recession: The gap between 3-month and 10-year rates is now negative. In the lead-up to the economic downturn that began late in 2007, this part of the curve initially flipped to inverted in early 2006. The curve’s latest collapse came amid reports showing weakness in France and Germany, while an index of American manufacturing slowed.
The days ahead bring readings on the U.S. housing market and consumer confidence, which may help investors gauge the Fed’s next step after policy makers unexpectedly scaled back projected rate hikes this year to zero. There will also be an array of Fed speakers to weigh in on the developments, not to mention a planned Brexit vote in the U.K. Parliament.
“The Fed’s actions and commentary have given investors the impression that they know something that the rest of the market doesn’t know about the future of the economy,” said Kevin Giddis, head of fixed income at Raymond James in Memphis, Tennessee. “This is a classic momentum trade now that favors risk-off that is leading us toward the conversation about a recession.”
He’s focusing on the data this week that are leading indicators, like housing starts, to see if the economy is actually faltering. Bond investors seem to be leaning in that direction, even as the labor market is the tightest in decades. The benchmark 10-year note yields 2.43 per cent, close to its lowest since January 2018. Giddis sees it ending the year at 2.25 per cent.
Money-market traders are also ramping up bets that a rate cut is coming, even as policy makers still have their next move penciled in as a hike in 2020. Fed funds futures show traders see about an 80 per cent chance of a quarter-point easing this year, up from about 30 per cent early last week.
While the San Francisco Fed calls the 3-month-to-10-year spread the most useful for forecasting recessions, some investors aren’t convinced by this latest market signal.
Michael Kushma, chief investment officer for global fixed income at Morgan Stanley Investment Management, says this part of the curve “is distorted” by global forces fueling demand in the long end. And increased bill supply is elevating short-end rates, he said.
The demand for new Treasuries with 2-, 5- and 7-year maturities may get a lift from tumbling yields worldwide. The sales will also offer investors a chance to pass judgment on the Fed’s decision to end its balance sheet roll-off sooner than some expected.
“The auctions will clarify investor commitment to Treasuries at these new lower levels,” said Jim Vogel, a strategist at FTN Financial. “The auctions will also clarify where people want to put their money on the curve. You can’t avoid the taper when you have to commit billions of dollars to Treasuries.”
Treasury futures trading was active from the open in Asia with volumes running at double the normal for the time of day, while the 10-year bond yield fell one basis point to 2.43 per cent.
What to Watch
-On the geopolitical front, traders will be monitoring trade talks, with President Donald Trump saying a deal with China is “getting very close.”
-And Fedspeak kicks into high gear:
-March 24: Chicago Fed’s Charles Evans speaks in Hong Kong at 9:45 p.m. New York time
-March 25: Evans speaks in Hong Kong at 1 a.m. New York time; Philadelphia Fed’s Patrick Harker in London; Boston Fed’s Eric Rosengren at conference in Hong Kong, at 8:30 p.m. New York time
-March 26: Evans in Q&A in Hong Kong; Harker speaks in Frankfurt; San Francisco Fed’s Mary Daly
-March 27: Kansas City Fed’s Esther George
-March 28: Fed’s Randal Quarles in Frankfurt; Fed’s Richard Clarida in Paris; New York Fed’s John Williams visits Puerto Rico; St. Louis Fed’s James Bullard; Fed’s Michelle Bowman
-March 29: Dallas Fed’s Robert Kaplan; Quarles again
-For economic releases:
-March 25: Chicago Fed activity index; Dallas Fed manufacturing index
-March 26: Housing starts and building permits; FHFA house price index; S&P CoreLogic home prices; Richmond Fed manufacturing; Conference Board consumer confidence
-March 27: MBA mortgage applications; trade balance; current-account balance
-March 28: Jobless claims; 4Q GDP; Bloomberg consumer comfort ; pending home sales; Kansas City Fed manufacturing
-March 29: Personal income and spending; Chicago PMI; new-home sales; University of Michigan sentiment
-Here’s the schedule for Treasury auctions:
-March 25: US$48 billion of 3-month bills, US$39 billion of 6-month bills
-March 26: US$26 billion of 52-week bills, US$40 billion of 2-year notes
-March 27: US$18 billion of 2-year floating-rate notes, US$41 billion 5-year notes
-March 28: 4- and 8-week bills, US$32 billion of 7-year notes