Bloomberg
Published Aug 20, 2019 02:30AM ET
Updated Aug 20, 2019 05:08AM ET
Inverted Yield Curve: Is It Time to Worry Yet?
(Bloomberg) -- Last year, U.S. 10-year yields weren’t low enough to really boost the equity market’s appeal. This summer, the inversion of the yield curve is suddenly triggering worries of a U.S. recession, while bund yields are deep into negative territory as Germany seems heading for an economic downturn. Yet there’s few signs of panic among equity traders.
Many in the market agree that a U.S. recession isn’t imminent. UBS strategists see the inverted yield curve more as “a statement on lackluster growth in the rest of the world,” and suggest a slowdown would take some time to materialize.
One interesting point they note is that European equities seem to have been more vulnerable than U.S. stocks to the gyration of the U.S. 10-year bond yield over the past six months.
The U.S. 10-year yield has only fallen below 1.6% on two previous occasions: mid-2012 and mid-2016. According to Citi strategist Jonathan Stubbs, it has worked well as a buy signal for European equities both times, with the DAX returning 23% on average over the next 12 months, the CAC 24%, and the FTSE 17%. Of course, with Fed cuts, ECB QE and trade concerns, things may be different this time, he says.
So, should we be worried? Not yet, according to JPMorgan (NYSE:JPM) strategists including Mislav Matejka. Over the past six historical episodes, yield-curve inversion preceded recessions by 17 months on average, while the equity market peaked about 11 months after the inversion, they write. Even if the risk of a downturn next year is increasing, much can happen in the meantime. They still expect equities to make all-time highs into the first half of 2020 and see the current pull-back not lasting beyond early September as the ECB will start quantitative easing and the second Fed rate cut might be bigger than the first.
The bounce in the U.S. 10-year yield over the past couple of days may have also provided some relief. Indeed, Bank of America (NYSE:BAC) technical analysts note that extreme momentum has pushed the monthly Relative Strength Index (RSI) of the U.S. 10- and 30-year bonds into their fourth and fifth-most overbought level ever. This may signal an imminent “key low” or “pivot low.”
And not all is bad about negative yields anyway. The more bond yields move deep into negative territory, the more stocks are seen by many as the only attractive asset. Why buy a bond on which you’re guaranteed to lose money while you can buy stocks with lofty dividend yields of 5% or more?
True, if held until maturity, government bond yields don’t look appealing. But on an absolute-return basis, some long-duration securities beat stocks. Notably this year, Austria’s 100-year note has delivered investors as much as an 80% return so far. Granted, the timing must be right and liquidity could be an issue.
Finally, let’s not forget about another silver lining. With Germany facing the danger of a recession, the government has signaled it stands ready to inject stimulus if things turn sour. Since the bund curve has turned negative across all maturities, financing those fiscal measures in the long-term is even more appealing.
In the meantime, Euro Stoxx 50 futures are trading little changed ahead of the open, while S&P 500 contracts are up 0.2%.
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Written By: Bloomberg
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