Upside Down…the Yield Curve Inverts
Recently, the big news has been that the U.S. Treasury (UST) 3-month/10-year yield curve became inverted for the first time since 2007. It is certainly a noteworthy development in bond-land. As of this writing, the closely watched UST 2-year/10-year spread is still on the positive side at 15 basis points.
Here are some quick insights:
- The effect of last month's Federal Reserve (Fed) meeting is still resonating, with any economic data being viewed through that prism accordingly.
- The catalyst for this latest inversion may have been the continued soft performances of the eurozone Purchasing Managers' Indexes (PMIs), specifically those of the manufacturing sector and Germany.
- The manufacturing PMIs for Germany, France and the eurozone are now all in recession territory, with Germany’s at its lowest level since 2012.
- The 10-year German bund yield dropped into negative territory as a result of the PMIs.
- This is important for the U.S. rate outlook because the Fed mentions global growth as one of its primary concerns.
- U.S. economic data has been more mixed but does suggest a slowing in Q1 growth.
- The U.S. PMI came in below consensus for March, but still safely above the “50” threshold of contraction versus expansion.
- Existing home sales increased by 11.8% in February.
- The data on housing, an interest-rate sensitive sector of the economy, is important because if the rise in U.S. rates is going to start having negative repercussions, this is a logical place for it to start.
- At its meeting last month, the Fed lowered its 2019 gross domestic product (GDP) forecast by only 0.2 pp and kept core PCE unchanged. Three months ago, a somewhat similar scenario resulted in two rate hike projections, but now the result is none. Following the December FOMC meeting, the Fed may be operating with an overabundance of caution.
- The most important outcome of the March Fed meeting may be that there was no mention of, or forecast for, rate cuts. In contrast, fed funds futures have now priced in one rate cut for this year.
- The UST 10-year yield broke through the five-year Fibonacci 61.8% retracement of 2.5178. The next level is 50% retracement at 2.2887.
- I’m not necessarily projecting this is where we go, but if upcoming U.S. economic data comes in soft, the glide path is there.
- What about U.S. economy surprises to the upside? The UST market is not priced for this scenario at all. In fact, the UST 10-year relative strength index is back in “overbought” territory. It’s had a good track record.
Unless otherwise stated, all data is Bloomberg, 3/25/19.