Yields rise from three-year lows, trade concerns remain

Andrew Cummings
August 21, 2019

Yields of the US long-dated and short-dated treasury bills all declined on Wednesday. Rattled investors then rushed to long-term safe haven assets, pushing the benchmark 30-year Treasury yield to a record low.

Compared to the free-swinging and sometimes emotional stock market, the bond market is supposed to be the sober and measured one.

Yields on 10-year U.S. Treasury notes fell below the two-year yield, intra-day, for the first time since 2007, in what is known as a yield curve inversion and widely seen by investors as a sign that a recession is coming.

The two-year Treasury yield briefly exceeded the 10-year Treasury yield.

All of which is heightening fear about the United States economy and about whether the 10-year expansion, the longest on record, is nearing an end. The global bid for bonds also inverted the two-year to 10-year United Kingdom yield curve Wednesday.

The president also insisted his trade war with Beijing is not the cause of the market turmoil.

Joseph Brusuelas, chief economist at RSM US LLP, said the trade war between the USA and China is the clear catalyst for the inversion.

The S&P Europe 350 Index was down more than 1.5%, while London's FTSE 100 was also trending down, as was France's CAC and Germany's DAX. After all, the trillions they invested in the Treasury market were to stimulate the economy by driving down borrowing costs through the economy, boost liquidity and make higher-risk assets look more attractive.

After its early dip, the yield on the 10-year Treasury stood at 1.58 percent, even with the yield on the two-year. Given the continued strong employment picture and healthy USA consumer, there could still be time for this economic cycle to have plenty of life left.

When the three-month yield rose above the 10-year yield earlier this year, it drew more attention. The National Bureau of Economic Research, a private organization of economists that formally defines recessions, say they occur when there is: "a significant decline in economic activity" lasting for more than "a few months", reflected in a range of economic data, including GDP, incomes and jobs.

The price of benchmark US crude slid $1.87, or 3.3 percent, to settle at $55.23 per barrel.

More specifically, Mark Haefele, global chief investment officer at UBS Wealth Management, pointed out in a research report on Wednesday that treasury yields were weighed down by the nearly 16 trillion dollars in sovereign bonds globally with a negative yield, distorting their signal about USA economic activity.

Forget the name of the instrument, effectively, these just are one of many instruments institutional traders use to express a view on future inflation expectations, and exchange their liabilities. Meanwhile, the 30-year Treasury yield also hit a record low Wednesday.

The German bond yield curve is not yet inverted but is at its flattest since 2008. Brent crude, the worldwide standard, dropped $1.82 to close at $59.48. The Nasdaq composite lost 3% to 7,773.94.

Roughly, the interest rate on a long-term bond should be the average interest rate on short-term bonds that will prevail during the term of the long bond, plus a "term premium" to compensate the lender for risks associated with lending on fixed terms for a long period.

All of this serves to explain why the bond market is heating up. The Federal Reserve Bank of New York's index showing the probability of a US recession over the next 12 months is close to its highest level since the global financial crisis, at around 31 per cent.

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