US bond market flashes warning signal of economic slowdown

The Treasury bond market flashed a warning signal on Tuesday and investors piled into haven assets, evidence of the fears of potential recession that have gripped global markets.

Yields on 10-year US government bonds slumped below those on two-year notes for the third time this year. So-called inversions of the yield curve have preceded every US recession in the past 50 years — not immediately, but within the subsequent two years.

Investor sentiment has weakened in recent days on signs that the persistent inflation that has elevated prices of products from fuel to food, along with rising borrowing costs as the Federal Reserve raises interest rates, are taking a heavier toll on businesses and households.

A survey late last week from the Institute for Supply Management on the US manufacturing sector pointed to declines last month in new orders and employment, intensifying concerns about the state of the world’s largest economy.

A forecast by the Federal Reserve Bank of Atlanta that takes into account incoming economic data now points to an annualized decline of 2.1 per cent in US economic output in the second quarter, following a drop in the first quarter. A recession is typically defined as two consecutive quarters of contraction.

In the UK, Bank of England governor Andrew Bailey warned “the global economic outlook has deteriorated markedly”.

Line chart of $ per € showing euro slides to lowest level in two decades

Meanwhile, the euro dropped to its lowest level in two decades as traders rushed into the safety of the dollar.

“The dollar remains this primary safe haven . . . and that is a factor which is exacerbating the [euro] movement. People want dollars in times of stress and anxiety,” said Jane Foley, head of FX strategy at Rabobank.

Investors are scaling back their expectations for Fed rate increases as the economic outlook dims. Futures markets indicate the US central bank is now expected to lift benchmark rates to 3.3 per cent by early 2023, down from projections three weeks ago of 3.9 per cent.

The Fed’s benchmark interest rate stands at a range of 1.5 per cent to 1.75 per cent following a series of increases this year.

Details of the Fed’s most recent monetary policy meeting, due to be published on Wednesday, may give further clues as to the extent to which it is willing to tighten monetary policy. A US jobs report on Friday will also signal the level of capacity in the country’s labor market, a criterion that may also influence Fed decision-making.

The slowdown in the US economy and the Fed’s still-aggressive tightening plans, however, have supplanted some fears of inflation. Oil prices — a crucial component of inflation metrics — on Tuesday sustained their heaviest falls since March, as concern about demand hit the commodities market. Brent, the international benchmark, tumbled 9.5 per cent to $102.77 a barrel, while US marker West Texas Intermediate dropped 8.2 per cent to $99.50.

Citigroup commodities strategists said on Tuesday that a recession was “increasingly likely”. They said in that scenario the oil price could reach $65 a barrel by the end of this year and $45 by the end of 2023, assuming Opec and its allies do not intervene in the market.

Fading inflation risks also led the Nasdaq Composite index higher, ending the day up 1.7 per cent. The index is heavily weighted towards tech stocks, which are particularly affected by inflation as a great deal of their valuations are based on forecast future earnings. The blue-chip S&P 500 stock index ended the day up 0.2 per cent.

Additional reporting by Nikou Asgari

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