The recent plummet in bond yields has hit risk appetite. What are yield curves telling us about the prospects of the US economy? We look at the key factors impacting across major forex, equities and commodities markets.
Recently markets have fretted over the implications of an inverted US Treasury yield curve. For weeks portions of the curve have inverted (spread between 3 months and 10 years has been negative since May). In recent days the spread between 2 years and 10 years went negative, albeit briefly. Studies show that curve inversions have been the precursor to the past five US recessions. The time between inversion and recession varies between 10 months to 36 months, averaging 22 months. The last time the 2s/10s spread was inverted was in 2006/2007, but then, the curve inverted across durations, including 5 year/30 year spreads (which are currently +57bps). The feeling is that significant factors are weighing on a curve which is still impacted by hugely loose global monetary policy, whilst the US economy is still chugging along nicely. The Fed is cutting due to the fear of the global slowdown infecting the US. A pre-emptive cut, but is the bond market telling the Fed they need to do more to prevent long term economic decline? US economic prospects are dependent on the consumer (which is c. 70% of the economy). Prelim Michigan Sentiment sent a shot across the bows, but July retail sales were very strong. However, if the consumer goes into a decisive retreat then there really could be something in an ongoing economic slowdown. A move into recession would need significant deterioration in confidence, a consistent run of monthly declining retail sales, further deterioration in inflation, and ISM below 50. These are some way off but will need to be watched closely.