Stocks drop as falling United States yields, trade worries hit mood

Stocks drop as falling United States yields, trade worries hit mood

The so-called "inversion" of the yield curve to many investors sounds an alarm about a looming USA economic slowdown. USA light crude was last up 30 cents at $53.25.

Economists at JP Morgan reckon the odds of Britain staying in the EU have increased to 40 percent from 20 percent previously, after the European Court of Justice's advocate general said Britain should be allowed to unilaterally revoke its departure notice.

The curve plots the difference between returns on long- and short-term US Treasury debt, usually 10-year notes compared to two-year notes.

Here's what that does: Yields on short-term bonds rise above those of longer-term bonds, historically a signal that an economic slowdown is around the corner.

Fed Chairman Jerome Powell reversed his tone last week, when he said the US central bank's policy rate is now "just below" neutral, a level at which rates neither boost nor put the brakes on the economy. The central bank's own large balance sheet may even be a culprit, by helping hold down long-term rates. Powell in remarks last week reiterated his upbeat outlook of an economy growing above potential, with the unemployment rate the lowest in almost 50 years, and in no need of emergency level interest rates. In its view, those rate hikes are putting the brakes on borrowing and hiring, keeping inflation under control. This is called an inversion of the yield curve, or at least a small piece of the curve.

When did the yield curve invert?

But on Monday, the yields on five-year Treasury notes fell below those on three-year notes, an inversion that hasn't happened since 2007.

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No - and that's why this latest flip in yields may not augur recession.

Global equities have been shaken as a flattening U.S. Treasury yield curve fans worries about a recession, and on growing doubts that Washington and Beijing will be able to clinch a substantive trade deal during a temporary cease-fire agreed at the weekend. But that hasn't happened yet, noted Charlie Ripley, senior investment strategist for Allianz Investment Management. It has spread to the euro zone, where the German 2-10 yield curve hit its flattest since mid-2017 at 85.70 basis points.

So should I brace for a recession?

"If that is indeed to be the case, the recent strong equity recovery is at risk from fundamental economic deterioration, a message that is sounding from the junk bond market, whose rebound has been far less impressive", he said. It's hard to say - but we prefer this explanation: Since December 2015, the Fed has implemented a series of 6 interest rate hikes and simultaneously cut its balance sheet by $50B a month. Asked about the possibility of an inversion at a June press conference, Powell said "what we really care about is what's the appropriate stance of policy".

"The market decline in the USA overnight and the flattening of the yield curve reflect that economic growth momentum is taking over as the primary concern for investors, even as the latest ISM manufacturing data is holding up well", wrote Tai Hui, market strategist at J.P. Morgan Asset Management.

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