The bond market sent a warning, and this time the stock market listened. Investors will be looking for clues in the week ahead that policy makers are listening, too.
The yield on the 10-year U.S. Treasury note on Wednesday briefly traded below the yield on the 2-year note, marking an inversion of the yield curve — a phenomenon seen as an often reliable recession indicator, albeit with an average lag of more than a year. In fact, the 10-year yield has traded below the 3-month T-bill yield since late May — an inversion of that portion of the curve is seen by economists as an even more reliable recession indicator.
But the latest twist came amid a run of downbeat economic data out of Asia and Europe, as well as an intensifying U.S.-China trade war.
‘Headline warning shot’
The latest inversion doesn’t guarantee doom, but it is “a headline warning shot about what’s been going on over the last few months,” said Joe Mallen, chief investment officer at Helios Asset Management, which manages $16 billion in combined adviser assets, in an interview.
“At a very high level, people are really now genuinely concerned about a recession in the U.S. in the next two years, and I think that’s fair,” he said.
It was a volatile week for the stock market. The Dow Jones Industrial Average
slumped 800 points, or 3.1%, on Wednesday for its biggest one-day percentage fall of 2019, while the S&P 500
tumbled 2.9% in the inversion-inspired selloff. Equities ended mostly higher Thursday and then reclaimed a sizable chunk of ground Friday, but still ended lower for the week. The S&P 500 saw a 1% weekly decline, while the Dow fell 1.5% and the Nadsaq Composite
was down 0.8%.
Stock-index futures pointed to a higher start Monday, buoyed by upbeat comments by President Donald Trump on trade talks, along with a move by China over the weekend to lower borrowing costs for companies.
The 10-year/2-year measure of the curve ended the week with a small upward slope after Wednesday’s brief inversion. But stock-market investors were also spooked by the size and speed of the rally in Treasurys, a popular haven during periods of uncertainty. Yields, which move the opposite direction of bond prices, fell sharply to multiyear lows or, in the case of the 30-year Treasury bond
an all-time low, dipping below 2% for the first time ever before ending the week at 2.001%.
A global story
Of course, the moves in the Treasury market aren’t all — or perhaps even mostly — about the U.S. economy. That speaks to ideas the Treasury rally is overdone, and vulnerable to a pullback that could see yields rebound in the near term.
“The bond market rally is as much a global story as a U.S. one,” said Kit Juckes, global macro strategist at Société Générale, in a Thursday note, observing that weak data in Asia and Europe were the culprits in sparking the Treasury rally that dragged down yields on Wednesday. “But at some point, U.S. data need to justify the fall in U.S. yields, or at least a bigger part of them than recent data have.”
The burgeoning supply of debt around the world that offer negative yields — the entire German government bond yield curve is now in subzero territory — means Treasurys remain attractive, even if their yields are near or at all-time lows.
That factor is one reason some investors argue the inversion of the yield curve might not offer as reliable of a signal about the economic outlook as it has in the past. But those external factors might be of limited comfort.
“The bottom line here is that markets fear the U.S. is being sucked into the very low/negative rate vortex that is consuming European sovereign debt,” said Nicholas Colas, co-founder of DataTrek Research, on Thursday. “The signal that sends: Japan-style deflation and eurozone-like economic stagnancy. Not good.”
On the other hand, low Treasury yields should be a positive for stocks, in general, from a valuation perspective. And a record low 30-year bond yield should be a positive for housing.
Focus on the consumer
But the main worry for stock-market investors rests with the U.S. consumer, who remains a pillar of the economy, said Mallen.
Indeed, stronger-than-expected July retail sales data and upbeat results from Walmart Inc.
were credited with stabilizing stocks after Wednesday’s inversion-inspired rout. But heightened recession fears can become a self-fulfilling prophecy if consumers pull back on spending.
All eyes on Jackson Hole
That puts the onus on the Federal Reserve and Chairman Jerome Powell. Fed officials and some of the world’s other top monetary policy makers gather in Jackson Hole, Wyoming, beginning Thursday.
Analysts and investors said the Fed could go a long way toward calming the nerves of consumers as well as investors — though probably not Trump, who constantly bashes the Fed for what he sees as insufficient speed in cutting rates — if Powell and fellow policy makers engage in some market-oriented hand holding.
A quarter-point rate cut by the Fed in September would likely be a disappointment, Mallen said. A signal that the Fed is prepared to be “a little more aggressive” in light of the recent developments in the yield curve would offer reassurance.
“The comments, or lack thereof, from the Fed are probably going to move the markets one way or the other,” Mallen said.