U.S. Markets closed

Treasury Market Calls Time on Fed Hikes as Curve Finally Inverts

Matthew Boesler and Katherine Greifeld
One by One, Global Bond Markets Are Flashing the Same Warning

(Bloomberg) -- The inversion of the Treasury yield curve shows bond traders see a worsening economy pushing the Federal Reserve to make its next interest-rate move a cut, even if officials seem reluctant to concede that just yet.

U.S. central bankers sent interest rates plunging on March 20 by slashing their projections for future increases. Weak European and American manufacturing data two days later cemented the notion that their tightening campaign may be over, with yields on 10-year Treasuries slipping below 3-month rates for the first time since 2007.

The growing specter of an economic slump sent a shiver through financial markets Friday, hitting not only bond yields, but also also dragging down share prices and hammering emerging-market assets.

The so-called inversion of the Treasury yield curve has heralded recessions in the past. The idea is simple: the Federal Reserve typically responds to downturns in the economy by cutting rates. Investors anticipate the cuts and incorporate those expectations into longer-term yields, tilting the curve downward.

Analysts said the inversion indicates the Fed’s rate-hike cycle -- policy makers raised their benchmark overnight rate from near zero in December 2015 to just under 2.5 percent in December 2018 -- may be finished.

“One more hike isn’t worth the risk to the economy and stocks,” said Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets in New York. Friday’s upending of the curve supports the idea that the fed fed funds rate is at its terminal point for this cycle, he said.

The policy-setting Federal Open Market Committee surprised investors Wednesday when it signaled it no longer expected to raise rates this year. In December, the median projection on the 17-member committee thought two quarter-point hikes would be needed.

Downside Risk

In a post-FOMC meeting press conference, Fed Chairman Jerome Powell told reporters a slowdown in major overseas economies constituted a downside risk to the outlook for the U.S., which he otherwise described as “a positive one.”

The FOMC projections showed one hike next year but no additional tightening in 2021.

“Chinese authorities have taken many steps since the middle of last year to support economic activity, and I think the base case is that ultimately Chinese activity will stabilize at an attractive level,” Powell said. “And in Europe, you know, we see some weakening, but again, we don’t see -- we don’t see recession, and we do see positive growth still.”

Markets Roiled

Reports on manufacturing in Germany and France published Friday, based on surveys of purchasing managers, showed the slowdown there isn’t over yet, prompting global investors to sell stocks and drive rates lower. Later in the day, the purchasing managers index for U.S. manufacturing unexpectedly continued to moderate, piling onto the negative sentiment in financial markets.

For Tom Porcelli, chief U.S. economist at RBC Capital Markets in New York, a key question is whether there is a stabilization in economic indicators outside the U.S. While Powell earlier this week sounded an optimistic note about international prospects, “these PMIs are just not finding a bottom,” Porcelli said. “If he is to be taken at his word -- that it actually is sort of an international thing that is pushing them to the sidelines -- then today’s news is not good.”

Close to Neutral

Minneapolis Fed President Neel Kashkari, who sits on the FOMC but does not have a vote on rate decisions this year, weighed in Friday morning on Twitter as the yield curve inverted.

He argued the “very flat” curve suggested “we are likely close to neutral,” meaning he believes the current level of interest rates is close to a setting that would keep the economy growing at a stable rate.

“While I was opposed to earlier rate hikes I didn’t think we had yet crossed neutral and moved into a contractionary stance. My view of neutral has been 2.5 percent,” Kashkari tweeted. “But that might not be right. Neutral might be lower than I thought. In my view this is where the yield curve is helpful.”

The fact that the long end is leading yields lower “is consistent with the fact that investors are concerned about a slowing in global growth momentum,” said Gennadiy Goldberg, a rates strategist at TD Securities.

Easing Priced

U.S. money markets are priced for about half a percentage point of easing from the Fed over the next two years, according to interest-rate derivatives. The dramatic swing from December, when markets were still priced for additional tightening, raises questions about how bad the outlook would have to get before Fed officials would start cutting rates.

For Rajiv Setia, the New York-based head of U.S. and European rates research at Barclays Capital Inc., a further deterioration overseas might be enough to tip the scales. He recalled what happened during the 1998 emerging-market crisis.

“Asian growth was weak, the Fed was worried about global growth potentially leading the U.S. into recession, and they preemptively eased,” Setia said. “We might be in for a similar type of ride here.”

--With assistance from Emily Barrett, Misyrlena Egkolfopoulou and Mark Tannenbaum.

To contact the reporters on this story: Matthew Boesler in New York at mboesler1@bloomberg.net;Katherine Greifeld in New York at kgreifeld@bloomberg.net

To contact the editors responsible for this story: Brendan Murray at brmurray@bloomberg.net, Alister Bull, Benjamin Purvis

For more articles like this, please visit us at bloomberg.com

©2019 Bloomberg L.P.