Weekly Market Update: Yield curve inversion spooks markets

Mon 19 Aug 2019

Read our full Market Update Week 33

Market Analysis

Last week saw equities decline globally, both in local and Sterling terms. US stocks recorded a third straight week of losses as trade and growth worries unsettled investors, down -1.6% in Sterling. The typically defensive consumer staples and utilities sectors performed best within the S&P 500 Index, with the former given a boost from an earnings and revenue beat from Walmart. Energy stocks underperformed as oil prices surrendered a Tuesday rally. UK, European and Emerging Market stocks returned -1.5%, -2.2% and -1.7% respectively. Global stocks were down -1.9%, as recession concerns increased in Japan, Italy and Germany. The US 10-year and 2-year yield curve inverted briefly for the first time in 12 years, reflecting investor concerns. The US 10Y Treasury yield closed the week significantly down at 1.554%, while the UK 10Y Gilt yields were largely unchanged at 0.466%. Sterling was up +1.0% vs the Dollar and +2.0% vs the Euro. Gold was up +14% in USD terms, at $1,507 an ounce. Oil closed up +0.7% at $59.3 per barrel.

CIO Analysis

As predicted, yield curve inversion last week created a short-lived panic but markets quickly bounced back. For one, the yield curve, a plot of the rates for government bonds of all maturities, had been inverted since May and had again inverted some months before that. It was only the particular 2y-10y part which inverted last week, which makes it a more trader-related signal, as it doesn’t really change anything. Yet, especially if one reads the papers in August, one would think that a recession is ante portas, as investors flee stocks and pile into bonds, hoping for the return of some of their money, due to a hawkish Fed and relentless trade wars.  The narrative seems to be that all investors really need is a cabin in the woods, canned food, a shotgun, a pair of German Shepherds and to simply wait for the Zombie Apocalypse. Lesson of the week: bond traders are into short term capital gains as much as equity people. So the news could read that we are seeing a massive bond market rally, while equities are still very near their all time highs, on the back of a largely dovish Fed (hawkish only relative to trader expectations, but who can keep up with these?) and still be as true. Bottom line: right now the markets create more noise than fact. True, long yields are starting to look overvalued (if we think about bonds not as a safe haven but as an asset class people hold for capital gains), earnings were flat and the economy is slowing. This doesn’t change the fact that central banks are very willing to support risk assets and that’s all it has taken to keep the bull market going over the past decade. If trade wars don’t degenerate into currency wars, which is the real risk at this point, unless one trades gold, it’s good to remember that we have already seen these conditions in this cycle. Enjoy what is left of the Summer (unless you happen to live in London) and don’t… fight… the… Fed.

David Baker, CIO