U.S. Yield Curve: Inverting, or Reverting?

Mid Week Bond Update

U.S. Yield Curve: Inverting, or Reverting?

The loudest story in the U.S. bond market in 2018 is the flattening yield curve, headed toward inversion – and the recession which it nearly always portends. But what are observers to make of the steepening of the curve starting on Friday, July 20?


Source: Bloomberg, July 17, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

Yields rose across the curve.  The upward moves on the shorter end are fairly easy to understand, given the combination of the July 20th aggressive tweet from the President to the Fed about rates being raised and upward pressure on short-end yields resulting from $119 billion of Treasury auctions at 2-, 5- and 7-year maturities scheduled for the following week.

The long end rise -- including the 30-year yield, up from 2.9695% to as high as 3.1023% – could be due to optimism about a blow-out GDP report on Friday June 27 – current consensus is for a 4.2% annualized rate for 2Q, accompanied by a 3.0% rise in personal consumption since Q1.

A key take-away message: don’t let a dominant story blind you to a potential signal of change. Anything can happen – and often does. That’s why we diversify.

For more on the outlook for fixed income in the coming months, explore the latest from Western Asset: CIO Ken Leech: Quick Take: Market and Strategy Outlook.
 

On the Rise: China: Economic Stimulus and Trade Tensions

Monday saw several new economic initiatives from the government, including the injection of 502 bn yuan ($74 billion) into the financial system; cuts to tax rates for smaller businesses; and increased spending on infrastructure.

Not surprisingly, China’s stock markets rallied. But the measures also coincided with a fall in the value of the currency vs. the U.S. dollar. That change in relative value seemed to provoke the U.S. in its current trade proposals within North America, with the European Union (EU) and with China.

 

Source: Bloomberg, July 24, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

For more on the trade issue, explore Brandywine Global’s U.S. – China Trade: The Challenge

 

On the Slide: Turkey in the Weeds

The Turkish central bank’s most recent rate decision confounded expectations, holding the reference rate steady at 17.75% in the face of inflation running at roughly 15%. Not surprisingly, the Turkish lira headed downward yet again, reaching 4.8810 per U.S. dollar as of early Wednesday, July 25, Ankara Time.

 

Source: Bloomberg, July 24, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

The issues facing Turkey go well beyond rates.  Newly reelected President Recep Tayyip Erdoğan has lobbied for a lower base rate, suggesting that the central bank’s independence is an impediment to growth. Appointing a relative to the post of Finance Minister further eroded perceptions that the economy is in the hands of professional technocrats. Beyond financial policy, worries about the conflict on Turkey’s southern borders with Syria and Iraq add to the concern on the part of observers, financial and otherwise.

 


All data Source: Bloomberg as of July 24-25, 2018, unless otherwise specified.
 

Definitions:

Technocrats are government officials who are technically proficient in their areas of expertise, such as economists, financial anslysts and the like.

The yield curve is the graphical depiction of the relationship between the yield on bonds of the same credit quality but different maturities.

Inverted yield curve refers to a market condition when yields for longer-maturity bonds have yields which are lower than shorter-maturity issues.

 

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