An inversion in U.S. Treasury yields, a solid and reliable predictor of past recessions, is at most two years away and perhaps only a year off, according to bond market experts polled by Reuters who have brought their forecasts nearer.
While there is still plenty of optimism around the global economy, there are signs that growth in several economies has already peaked, putting a brake on stock markets and sending rising bond yields back in the other direction.
The real risk of a global trade war as a result of U.S. President Donald Trump’s tariff spree also suggests more trouble ahead, according to foreign exchange and stock market strategists and fund managers.
The latest survey of over 80 bond strategists taken June 25-28 comes days after a Reuters poll of economists showed rising recession risks in the U.S. economy, where growth momentum is due to wane in the second half.
“The days of above 3 percent yield on the 10-year Treasury seem now in the distant past, and there is a feeling in some quarters that we may have already seen the peak yield for the year,” noted Bruno Braizinha, interest rates strategist at Societe Generale.
“The recent bout of geopolitical uncertainty and newsflow on trade wars and emerging markets has helped keep the yield under 3 percent. The Fed helped by delivering a hawkish surprise at its June meeting, which may risk frontloading the timing of a U.S. slowdown - our economists’ core scenario is for a recession in late-2019/early-2020,” added Braizinha.
The U.S. 10-year yield rose to over 3 percent last month for the first time in more than seven years. That came in part on an expected increase in Treasury supply to fund a swollen budget gap from aggressive tax cuts passed by Congress late last year.
But it has since plunged about 30 basis points from its recent peak to a four-week low of 2.83 percent on rising concerns about a trade war, despite also-mounting confidence about Federal Reserve interest rate hikes being delivered steadily through this year and next.
That diverging view on long-term growth and short-term interest rates has pushed the yield differential between two-year and 10-year notes to just 32 basis points, the narrowest gap since 2007 at the start of the last recession.
The yield curve inverts when the yield on short-term maturities is higher than longer-dated ones. In a strong economy set for a long expansion, the reverse is the norm, as investors demand higher returns for holding bonds for longer.
U.S. 10-year Treasury yields are forecast to rise by about 50 basis points from here to 3.30 percent in a year, with two-year yields due to rise by more, to 3.05 percent.
That would bring the yield gap to about 25 basis points in a year, the lowest since over a decade ago, and around the time when much of the world was about to plunge into the worst global recession since the Great Depression. (Graphic on historic and expected yield moves: https://reut.rs/2KvqzZQ)
“The yield curve could be less than two rate hikes away from inversion,” noted Chris Low, chief economist at FTN Financial, referring to an event that has correctly predicted nine of the last ten recessions.
“With 10-year notes trading between 2.90 percent and 2.95 percent since the June (Fed) meeting and 2-year notes at 2.55 percent, 10-year yields have to rise quickly to avoid a flat 2s/10s curve.”
Sixty-five percent of 40 strategists who answered an additional question expect the yield curve to invert in the next one to two years, including four respondents who said that would happen within a year.
The other third said it would invert in two to three years or more, which was the majority view just three months ago.
The expected rise in the two-year Treasury yield - most sensitive to official interest rate moves - is also just a bit more than half the roughly 100 basis points hike to fed funds rate in a year predicted by economists.
“FOMC members are convinced long-term rates will rise, but the long-end remains stubbornly below expectations,” added FTN’s Low, referring to the Federal Open Market Committee.
“The fact they (longer-dated yields) are no longer rising suggests a market consensus (that) the Fed has charted a course for lower-than-2 percent inflation, a recession, or both by the end of 2020.”
Benchmark bond yields in the euro zone, Britain and Japan are expected to climb along with U.S. Treasuries as the Bank of England contemplates a rate hike and as the European Central Bank attempts to shut its bond buying program by end-year.
But the expected rise is modest despite the outright or impending shift in global central bank policy away from ultra-easy monetary policy and instead shows preference for sovereign bonds to be well-bid.