Yield-Curve Inversion Deepens, Traders Brace For Trade-Driven Recession

The Ten-Year Yield Hit A New Low

The yield on the ten-year treasury fell on Thursday to its lowest level in two years. The move was sparked by growing concern the U.S./China trade war will linger on far longer than first anticipated. The recent escalation in tensions, the hiking of retaliatory tariffs, and the threat of an all-out tech-war have raised the odds of a global economic recession.

The decline in yield rates was across the board. The decline in rates is an indication of buying, when investors are buying bonds its because they believe equities will underperform or even enter a bear market. With Thursday’s drop in ten-year rates the U.S. yield-curve inversion deepened.

The inversion, when the ten-year note yield is lower than the three-year bill, is a closely watched indicator of future recession and has been flashing its warning signal for months. When the ten-year yield is below the 3-month treasury it means investors believe interest rates are going lower and they want to lock in the higher-rates now.

The yield-curve inversion signal was enhanced by Thursday’s read of Flash Markit PMI that came in below expectations. The read on PMI shows economic expansion slowed much more than expected in the last month and on the verge of contracting.

Traders Are Expecting Lower Interest Rates

The Fed, largely responsible for controlling interest rates, has indicated it will not be hiking rates soon. Their stance has weighed on rates for bonds keeping short-term rates near the FOMC target rate. The market, for its part, is indicating the FOMC is more likely to lower rates than hikes. The CME’s FedWatch Tool is showing a 75% chance of a rate hike by December, a move that looks ever more likely.

Notably, the yields on all Treasuries from the 1-mos to the 10-year are below the Fed’s target 2.50%. This shows a general acceptance within the bond market that the FOMC will be lowering their interest rates sometime in the not-too-distant future.

The downside to the yield-curve inversion signal is that is very unreliable. While it is a reliable indicator of recession it does not give a precise time when the recession will happen. Historically the recession tends to follow 1 to 3 years behind the inversion. The stock market tends to keep rising after the inversion until it hits a peak. This time around the market peak may be coincident with the escalation of trade tensions between the U.S. and China.