ANNOUNCEMENT: Expert Investor is now PA Europe. Read more.

Bond managers fear self-fulfilling bear market

As the spread between two and 10-year treasury yields narrows jittery investors look like they are starting to panic

Hysteria about the flattening-out of the US treasury yield curve is in danger of becoming a “self-fuelling bear market” that could eventually lead to a recession, investors fear.

Last week’s inversion of the three-year and five-year treasury yield curves added fuel to the fire for markets that were already jittery from unanswered questions about president Trump and Xi Jingping’s tête-à-tête at the G20 summit.

Axa IM fixed income CIO Chris Iggo said the coverage of the inversion via all the usual “hysteria channels” arguably led to the “violent sell-off in bank stocks” that took the S&P 500 down over 3% last Tuesday, resulting in one of its worst intra-day sell-offs of the last five years.

In his eponymous weekly blog, Iggo’s Insight, he said the hysteric coverage of the yield curve inversion could “drive a self-fuelling bear market”.

Red flags were first raised in September when the spread between the two and 10-year treasury yields narrowed to 0.2%, its lowest level since August 2007.

In the months since, the yields on the two US government coupons have moved closer together with just 0.09% separating them.

“So, the sequencing for the bear is, yield curve inverts, stocks tumble, confidence falls, real economic decision-making becomes more cautious, the data weakens as a result and stocks fall further, causing interest rate expectations to decline and the yield curve to invert more,” said Iggo.

Self-fulfilling prophecy

Rathbones head of fixed income Bryn Jones agreed that an inverted curve “puts a bit of a squeeze on the banks”, which trickles down to the consumer.

“If [the banks] haven’t got a steep enough curve and net interest margins are affected, then the banks might start to think ‘maybe I won’t lend so much money as aggressively as I have done before’.

“The knock-on effect is that lending drops and then spending drops, and consumer weakness becomes a self-fulfilling prophecy.”

No recession tomorrow

But Jones said an inversion toward the front end of the curve in and of itself does not mean a recession tomorrow.

He notes that in 2005 it took 28 months from the inversion of the three-year and five-year curves before the economy was in recession.

“Curves can invert and remain inverted for a while,” he explained. “It’s only when the ultra-long end inverts over the very short end when you get a truly inverted curve that is a clear signal you should start to worry about a potential recessionary impact.”

He added that bull markets in risk assets and equities throughout history have still occurred when curves are flat.

“The five-year to 10-year is pretty flat but you’re still getting one of the longest bull markets in equities history.”

Market says Fed is done

Iggo said the current flattening of the yield curve gels with his own views of a weaker economy starting in the second half of 2019 and going into the US presidential election year of 2020.

Though he admits we could be at the start of the process where the Fed eases up on its aggressive rate-raising path, this would not see the US heading into a recession for the next 12 to 18 months.

Meanwhile “the market is now saying that in December the Fed is done,” he said. “I don’t agree with that conclusion.”

Trapped bulls

Brooks Macdonald co-founder and Defensive Capital Fund manager, Jon Gumpel, said the US treasury yield curve inversion is a signal that the US economy is unable to cope with higher rates. Meanwhile global growth is slowing.

“No country is an island to misquote John Donne. I don’t think the US can do it all by itself which is a shame because we hoped the US could pull the world out, but it can’t.”

In any case he added: “We are probably due a recession.”

“It’s only because people get so committed to their bullish positions that it has to be such an awful thing. To my mind all the fuss about it is that there are a lot of trapped bulls out there.”

For more insight, please click

  • Can M&A and buybacks breathe life into UK market?

    Can M&A and buybacks breathe life into UK market?

    Both buybacks and M&A should help realise value in UK shares, boosting prices and giving investors another reason to consider the UK stockmarket Not only does M&A activity appear to be picking up, with a high-profile bid for UK electronics retailer Currys, but the scale of company buybacks continues to accelerate. If it goes well,…

  • Capital Group launches multi-thematic Article 8 funds

    Capital Group launches multi-thematic Article 8 funds

    Capital Group has launched a set of multi-thematic sustainable funds that are available for investors in Europe, writes Christian Mayes. The Capital Group Sustainable Global Opportunities fund (LUX) will invest in global equities, while the Capital Group Sustainable Global Corporate Bond fund (LUX) will target fixed income exposure. The launch also includes a multi-asset offering…

  • Bond funds pull in €29.7bn in January – LSEG

    Bond funds pull in €29.7bn in January – LSEG

    Bond products were the best-selling asset class in January, according to LSEG Lipper’s European Fund Flow report, writes Christian Mayes. The asset class pulled in a net €29.7bn in the month, while Money Market USD grouping was the best-selling Lipper Classification after receiving €11.2bn inflows. Providers of mutual funds pulled in €22.5bn, while passives saw net…

  • Quarter of Article 8 funds at risk of greenwashing – MainStreet Partners

    Quarter of Article 8 funds at risk of greenwashing – MainStreet Partners

    A quarter of all Article 8 funds could be accused of greenwashing based on their sustainability framework and practices, according to MainStreet Partners, writes Christian Mayes The 24% of funds classified as a greenwashing risk by the 2024 ESG Barometer report marks a four percentage point increase from the 20% flagged at the end of…

  • EU green rules could stymie decarbonisation projects – ExxonMobil

    EU green rules could stymie decarbonisation projects – ExxonMobil

    The European Union’s climate regulations may lead to it halting its investments in Europe, ExxonMobil has warned. Speaking to the Financial Times, Karen McKee, president of the product solutions division, said the oil and gas giant had struggled to begin decarbonisation projects in Europe due to the regulatory burden. The result, she added, was that…

  • ICE flags need for Europe to double green investment

    ICE flags need for Europe to double green investment

    Investments to modernise energy and transport must double by the end of the decade to reach 2030 climate targets, the EU has been warned. According to the Institute for Climate Economics (ICE), which has released the European Climate Investment Deficit report, the bloc lacks what it calls a “consistent tool” to ensure monitoring of the…