Does the Inverted Yield Curve Mean a US Recession Is Coming as US Stocks Suffer Worst Day of Year?

By Daniel Kruger, The Wall Street Journal

06 August 19

Yield on U.S.’s benchmark 10-year Treasury notes touches lowest intraday level since October 2016

​overnment bond yields plumbed multiyear lows around the world and an important market-based recession indicator flashed new warning signals Monday, spurred by investors’ worries that intensifying trade tensions will drag on the economy.

The yield on the benchmark 10-year Treasury note, which helps set borrowing costs on everything from mortgages to corporate loans, declined for a fourth consecutive session, falling to 1.738%—its lowest close since October 2016. The yield was 1.864% Friday.

Bond yields, which fall as prices rise, dropped around the world, and major stock indexes slid from New York to Hong Kong amid concerns that escalating trade frictions would exacerbate a slowdown in economic growth. Investors often seek the relative safety of government debt when they are worried about the economy.

“Markets are rightly correcting—they need to readjust to the new outlook for global growth,” said Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management. “We’re definitely in uncharted territory and investors are in for a rocky end of summer.”

In a cautionary sign to investors, the yield on three-month Treasurys exceeded the yield on the 10-year note by the widest margin since April 2007. Investors watch the dispersion between shorter- and longer-term yields closely because shorter-term yields tend to exceed longer-term ones ahead of recessions, a phenomenon known as an inverted yield curve.

At the same time, one measure of investors’ expectations for average annual inflation over the next 10 years—the 10-year break-even rate—fell to around 1.6% Monday from about 1.8% a week ago, according to Tradeweb.

The 10-year yield closed at its lowest level since before President Trump’s election, erasing a two-year-long climb driven by expectations that tax cuts and government spending would reinvigorate growth and spur inflation.

After a spike in growth fueled by 2017’s tax cuts, the benchmark yield climbed as high as 3.2% late last year. Some analysts said that climb showed the U.S. had finally broken out of a postcrisis rut of slow expansion and low interest rates.

The yield has retreated since, dragged lower by signs of slowdown around the world and concerns about the effect of Mr. Trump’s aggressive trade policies, factors many expect to prompt stimulus from central banks.

The 10-year yield posted its biggest four-session decline since November 2011 since the Federal Reserve’s July 31 decision to lower its benchmark federal-funds rate by a quarter percentage point, citing declining inflation expectations and the potential fallout from the trade fight. Investors widely expect another cut in September, especially after Mr. Trump’s promise late in the week to expand tariffs on Chinese goods.

The Chinese yuan weakened to a record against the dollar. One dollar bought 7.0980 yuan in offshore trading during the late afternoon New York session, with Mr. Trump on Twitter accusing China of manipulating its currency.

The 10-year yield fell to further lows in late trading after the Treasury Department designated China a currency manipulator. The yuan also extended its declines against the dollar.

The yield on Germany’s 10-year government debt fell to a record of negative 0.516%, while the yield on similar-maturity Japanese government bonds declined to negative 0.189%, the lowest in more than three years. Yields on two-year government debt in Germany, the Netherlands and Denmark settled at multiyear lows of less than negative 0.8%, according to Tradeweb.

Investors increased wagers that the Fed will accelerate its interest-rate cuts. Federal-funds futures, which investors use to bet on the direction of central-bank policy, recently showed about a 50% chance that officials will reduce rates three or more times this year, up from about 1-in-4 odds Friday.

The WSJ Dollar Index, which measures the U.S. currency against a basket of 16 others, fell 0.1%, with investors saying the Fed could reduce rates more than many had previously expected.

Some investors are concerned that lower interest rates may not boost the economy, particularly following surveys showing business leaders are increasingly worried about trade tensions. These concerns could limit business investment, which many expected to pick up later this year, and intensify the slowdown in growth, analysts said.

There have been discouraging headlines related to U.S.-China trade relations in the past, “but this time it feels a little worse,” said Larry Milstein, head of Treasury and agency trading at R.W. Pressprich & Co. “It doesn’t seem like there’s a way out.”