World stocks sideswiped by Wall Street, US yield curve double whammy

Marco Green
December 5, 2018

The signal is called the "yield curve", and it shows how the bond market is feeling about the USA economy's long-term prospects.

Adding to worries over the outlook for the global economy, the yield curve between USA three-year and five-year notes, and between two-year and five-year paper inverted on Monday - the first parts of the Treasury yield curve to invert since the financial crisis, excluding very short-dated debt.

Asian stocks slid on Wednesday, dragged down by Wall Street's tumble as sharp declines in long-term U.S. Treasury yields and resurgent trade concerns stoked investor worries about global economic growth. However, when investors expect interest rates to decline in the future - typically because of a weak economy - they scramble to lock in today's comparatively high interest rates for as long as possible.

Lyngen said the inversion of three- and five-year yields had increased the likelihood that an inversion of the two- and 10-year yield would happen by early 2019.

According to the Cleveland Federal Reserve, an inverted yield curve has preceded the last seven USA recessions.

Signals from the Federal Reserve last week that it may be nearing an end to its three-year rate hike cycle has pushed the 10-year U.S. Treasury yield to three-month lows below 3 percent.

No, at least not yet. Most economists are forecasting the US economy will continue to grow in 2019, though at a slower pace than this year. Shanghai markets (.SSEC) fell 0.6 percent, their losses limited by Chinese officials expressing confidence that a trade deal would be clinched on time.

"This solidifies not only my flattening bias but I think it will lead many players in the market who [expected the yield curve to steepen] to capitulate on that", Ian Lyngen, the head of united rates strategy at BMO Capital Markets, told CNBC.

As of writing, the 10-year bond yield was down 2.65% at 2.912%, the 5-year bond yield was losing 1.83% at 2.787%, and the 2-year bond yield was dropping 1% at 2.805%.

An inversion of this part of the yield curve has preceded each of the last nine recessions dating back to 1955.

The Dow Jones Industrial Average fell 799.36 points, or 3.1 percent, to 25,027.07, the S&P 500 lost 90.31 points, or 3.24 percent, to 2,700.06 and the Nasdaq Composite dropped 283.09 points, or 3.8 percent, to 7,158.43. Of course, that's still "pretty doggone tight", said Randy Frederick, vice president of trading and derivatives at Charles Schwab.

Japan's Nikkei stock index was 0.3 percent lower.

The Cleveland Fed, meanwhile, has focused on the difference in yields between three-month Treasurys and 10-year Treasurys.

"Inversion of that curve is the real recession red flag", said Neil Wilson, the chief market analyst at Markets.com. When the yield curve inverts, it means the two-year notes pay bondholders more in interest than 10-year notes do, something that's both rare and counterintuitive. Inverted yield curves have historically occurred during periods of economic recession. There have also been false positives in the past, where the yield curve has inverted but no recession has followed, such as in 1966.

Other reports by Click Lancashire

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