“The nearest thing the global economy has to a doomsday clock” has “ticked a little closer to midnight,” says Robin Wigglesworth in the Financial Times. Last week the US yield curve – which plots the interest rates on Treasury bonds of different maturities – inverted for the first time since the summer of 2007. That means that the US government briefly had to pay less to borrow money for ten years than for two years.
An inverted yield curve has preceded every one of America’s last seven recessions, which typically follow within 24 months of inversion. In effect, it shows that investors think that short-term interest rates are too high and that a downturn will force the Federal Reserve to cut them.
Americans are still spending
The Dow Jones index registered its biggest one-day fall of the year last week on news of the inversion. “The dominant mood in markets today… is not complacency but anxiety,” says The Economist. Traditional safe-haven gold is at a six-year high, while industrial commodities such as copper and oil have cratered.
Somebody forgot to tell American consumers about the “imminent recession”, says Justin Lahart in The Wall Street Journal. Retail sales rose 0.7% in July on the month before, easily beating predictions. Latest results from retailer Walmart also suggest that the almighty US shopper should continue to prop up global demand.
That is because “inverted yield curves have no predictive significance at all”, says Anatole Kaletsky for Gavekal Research. Seven recessions is too small a sample to draw firm conclusions. There have also been two “false positives” – the last in 1998 – when no recession followed inversion. Internationally, moreover, the phenomenon means little: Britain and Australia have both repeatedly seen yields switch around over the past three decades, even in periods of strong growth. Easy money and global demographics are driving the bond market, not the economic outlook.
A rational panic?
Not so fast, says Kallum Pickering in The Daily Telegraph. Previous yield-curve inversions have been explained away as the effect of commercial banks buying up bonds (1990s), or a global savings glut (2008). Yet recessions followed regardless. With serious political risks everywhere from Hong Kong to Iran to Britain, it is little surprise that investors are battening down the hatches. The yield-curve inversion should be taken seriously, but with US data still robust it is difficult “to tell how bad it actually is out there”, says Ben Levisohn for Barron’s. “It is time for caution, not panic.”
Surging bond and gold prices show that “we are in a panic” already, says Charles Gave of Gavekal Research. But barring a resolution of the US-China trade dispute there is no clear way out of the current impasse. Investors should keep a clear head and hedge equity risk with gold rather than bonds. A move into high-quality stocks would also be wise.