Wednesday 18 September 2019

Markets flash the red warning of a looming recession

Trade war: US President Trump’s hard line on China has added pressure to economies. Photo: AP
Trade war: US President Trump’s hard line on China has added pressure to economies. Photo: AP

David Chance

A key indicator that reflects market expectations of a looming recession in the US is burning more intensely as economic pointers increasingly turn south and interest rates across the world move deeper into negative or near-negative territory.

The spread of the yield on offer between the 2-year US Treasury bond and the 10-year bond hit just 1.5 basis points, or 0.015 percentage points - the narrowest level since 2007 when the global financial crisis was about to break.

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If the longer-term yields break below those of shorter -term paper, it indicates that financial markets expect lower growth and inflation in the future and as a result are willing to lend money for less than current rates because they expect lower demand going forward.

The push to ever-lower yields overall, even with €15 trillion of global bonds - around a quarter of the entire stock - already trading at negative rates, was given a further shove by a plunge in the German ZEW Index, which is a measure of confidence based on the outlook of 350 economists.

"The most recent escalation in the trade dispute between the U.S. and China, the risk of competitive devaluations and the increased likelihood of a no-deal Brexit place additional pressure on the already weak economic growth," said ZEW President Achim Wambach.

Many of the rich nations hit hard by the financial crisis have seen wages start to rise strongly as unemployment has dropped to levels not seen in 50 years. Germany was an outlier, outpacing most of the rest of the eurozone and amassing huge current account surpluses thanks to demand for its manufactured goods.

The downturn in Germany and slowing of the US economy, as well as a growing trade dispute between Washington and Beijing that threatens to entangle Europe too, has pushed central banks back to interest rate cuts, with the Federal Reserve leading the way.

That path looks set to continue, according to Dutch investment bank ABN-AMRO, whose Chief Economist Hans de Jongh said in its newly published assessment of the world economy that it had lowered its growth projections "a little further and are still below the consensus".

"The deteriorating outlook will trigger more central bank action than previously expected and this will have an effect on bond markets," Mr de Jongh wrote.

Slowing earnings growth and weakening manufacturing employment mean that the Federal Reserve is increasingly reliant on a faltering US stock market to deliver a boost to sentiment, according to Steven Blitz of TS Lombard, and that means it needs to signal more rate cuts to come.

"The Fed can help by confirming the next 50bp in rate cuts already priced into the market when the Federal Open Market Committee meets in mid-September. We will see if they take it," Mr Blitz wrote in a research report.

With most government debt in the eurozone yielding below zero, investors are asking when and if the US will follow and how long it will be before the benchmark 10-year U.S. Treasury breaks through the low of 1.318pc it set three years ago.

Some market participants are looking for a break to 1pc, others say yields will go even further, driven by demographics, a global savings glut and Trump's trade wars.

Irish Independent

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