Bond markets are sounding an alarm that the risk of a global recession is rising.
As the U.S.-China trade dispute puts the health of the global economy into question, bond yields on government debt around the world are undergoing a swift descent. Economic concerns were amplified on Wednesday when a trio of central banks in the Asia-Pacific region unexpectedly cut rates amid signs of slowing growth.
Negative interest rates are spreading throughout Europe and Japan, and the yield curve is inverted in both Canada and the United States. An inverted yield curve means longer-term interest rates are lower than short-term rates, which has often been a warning sign that the economy is about to slow down or contract after 10 years of expansion since the global financial crisis.
“When the bond market sends a signal as strong as this, it would be wise to listen,” said Frances Donald, chief economist and head of macroeconomic strategy at Manulife Investment Management.
The yield on Government of Canada 30-year bonds closed at a record low of 1.48 per cent on Wednesday, which is down from 1.74 per cent about a week ago, and a recent high of 2.59 per cent last October.
The Canadian yield curve inverted more aggressively on Wednesday: The 10-year yield fell to 1.24 per cent, or 11 basis points below the yield on two-year government debt. (A basis point is one-100th of a percentage point.) Under normal circumstances, in an economic expansion, longer-duration bonds should pay investors more than their shorter-term counterparts to compensate for the risk of inflation.
A similar inversion of yield-curve inversion has taken place in the United States, “to an extent that a recession now looks to be completely unavoidable,” David Rosenberg, chief economist at Gluskin Sheff + Associates Inc., wrote in a newsletter.
A closely watched U.S. recession indicator, the premium on three-month Treasury bill rates over 10-year Treasury yields recently rose to its highest level since 2007.
“Tack on inverted curves in Germany and Japan, [and] we’re talking global recession here," Mr. Rosenberg said.
The proliferation of negative interest rates, meanwhile, points to a rising level of discomfort on the part of investors about the health of the global economy.
Germany’s 10-year government bond yield fell to a record low of minus 0.58 per cent on Wednesday, after industrial production results that were much weaker than expected. Short-term rates are even more negative in Europe’s largest economy. A buyer of Germany’s benchmark two-year bond would have to pay $101.62 to receive $100 back in 2021, and receive no interest payments in the interim.
Around US$15-trillion worth of government bonds, representing one-quarter of the entire market, is now trading at negative yields, according to Deutsche Bank.
And the idea of creditors paying debtors to hang on to their money could soon be coming to the United States, according to Joachim Fels, global economic adviser at the bond investing giant Pacific Investment Management Co.
“If trade tensions keep escalating, bond markets may move in that direction faster than many investors think,” Mr. Fels wrote in a blog post.
Last week, U.S. President Donald Trump dashed the market’s hopes of a trade deal between the world’s two largest economies when he announced new tariffs on an additional US$300-billion worth of Chinese imports.
Compared with prior rounds of tariffs, the import charges taking effect on Sept. 1 will apply to far more consumer goods, including iPhones and computers.
“The U.S. consumer has been a key pillar, if not the only stable pillar of the U.S. economy,” Ms. Donald said.
In what seemed like retaliation to U.S. protectionist measures, China let its currency fall on Sunday, leading the U.S. Treasury Department to designate China a “currency manipulator.”
The move suggests that China has “all but abandoned” its efforts to come to an agreement with the U.S., Julian Evans-Pritchard, senior China economist at Capital Economics, said in a note.
“The PBOC has effectively weaponized the exchange rate,” Mr. Evans-Pritchard said. “They were holding back in order to avoid derailing trade negotiations.”
Mr. Trump took to Twitter on Wednesday, not to condemn the Chinese, but to blame U.S. Federal Reserve chairman Jerome Powell for the latest bout of market volatility and recession concerns.
“They must Cut Rates bigger and faster, and stop their ridiculous quantitative tightening NOW,” the U.S. President wrote.
Last week, the Fed cut policy rates for the first time since the global financial crisis, and the market is now pricing in at least one more 25-basis-point cut this year.
A dovish turn has seen central bankers around the world shift into stimulus mode, with rate cuts in New Zealand, Thailand and India all surprising the market on Wednesday.
It’s likely that “global synchronized easing [of monetary policy] becomes even more aggressive,” Ms. Donald said, which would be at least initially supportive for the economy and for stock markets.
That potential boost might help explain a large swing in stock-market sentiment on Wednesday, as what started as a day of steep losses for the Standard & Poor’s 500 Index turned positive by the closing bell.
Tim Shufelt