Business

Why are investors watching closely?

The bond market is sending warnings about the growth outlook for the global economy, as central banks prepare to tackle soaring inflation with higher interest rates.

The gap between long- and short-term government borrowing rates in major advanced economies has narrowed significantly since mid-October. For some investors, the so-called flattening of the yield curve is an ominous sign for the durability of the recovery from the Covid-19 pandemic.

“What the market is telling you is that this business cycle is likely to be a lot shorter than previous cycles,” said Mike Riddell, bond portfolio manager at Allianz Global Investors. “You don’t often see this type of flatness too early in the recovery process.”

What is yield curve?

Investors don’t have a crystal ball, but the yield curve is the next best thing.

The yield curve shows the interest rate that buyers of government debt require to lend their money for different periods of time – whether overnight, a month, 10 years or even 100 years.

Because lending to governments in major developed economies such as the US, Germany, Japan and the UK is considered a safe bet, these borrowing rates are mainly influenced by the rating investors about the outlook for economic growth and inflation, and what this rate will be. affect central bank interest rates.

The US yield curve in particular – thanks to the dollar’s central position in the global financial system – acts as a kind of barometer for investors’ general understanding of the future path of the world’s largest economy, and has a strong record of signaling recessions before they arrive.

“People are excited about the yield curve because, historically, it has been a good predictor of the onset of a recession,” said Richard McGuire, fixed income strategist at Rabobank.

The yield curve is typically upward sloping, whereby a higher fixed rate of return is obtained from lending money over a longer period. Short-term yields tend to represent what investors believe will happen with respect to central bank policies in the near future. Longer maturities represent investors’ best predictions about where inflation, growth, and interest rates will be in the medium to long term.

However, when an economy is slowing and inflation expectations fall, yields on 10- and 30-year bonds often fall to shorter maturities, such as 3-month and 2-year bonds. . because bond buyers bet that central banks are less likely to need to raise borrowing costs in the future.

This so-called flattening of the yield curve can at some point become a recession signal; especially if it becomes sloping down or reversed. The “inversion” of the yield curve has preceded every US recession in the past half-century.

McGuire explains that there are two possible explanations for this predictability. One is the collective intelligence of investors that serves as a kind of early warning system, identifying approaching dangers that individual forecasters struggle to spot. Another reason is that the change in the shape of the yield curve plays a positive role in causing a recession by undermining confidence in the economy.

In times of an expanding economy and very accommodative monetary policy, where governments use low interest rates to encourage spending and spur economic activity, the yield curve should rise. This happened after the 2008-09 financial crisis and earlier this year, after the recession pandemic.

The reason for this change is that bond investors expect higher yields in the future, because a stronger economy could spur a faster rate of inflation if demand in the economy kicks in. oversupply of goods or labor. In this scenario, the central bank would eventually need to set the overnight interest rate higher to encourage people to save more instead of spending.

Listening to the curve helps draw attention to key points in the data, such as descending notes along the yield curve indicating that it has reversed. It also exposes the data to a new audience, helping people who may not be able to see the chart listen to them instead.

Yields curve flashing warning sign before financial crisis

US Treasury Yield (%) chart by monthYield on US Treasuries (%) by monthone year5 years7 years10 years20 years30 yearsRemaining time until final repayment due date0first23456789January 2006
Federal Reserve Charts Effective Overnight | interest rate at the beginning of the month (%)Federal Reserve in effect overnightinterest rate at the beginning of the month (%)Depression200620072008Day0first234567892006

What’s been going on with the yield curve lately?

In 2019, the US yield curve inverted, fueling fears that the economic expansion that lingered after the global financial crisis was coming to an end.

As it turns out, a recession followed after the Covid outbreak led to the shutdown of a wide range of global economies. Even the most ardent proponents of the yield curve do not claim it can predict a pandemic. However, we will never know if the United States is ready for a recession, and the predictive power of inversions has maintained its stellar record. That is one reason why investors have been watching recent changes in the shape of the curve so closely.

Investors were expecting an economic downturn before the pandemic hit

US Treasury Yield (%) chart by monthYield on US Treasuries (%) by monthone year5 years7 years10 years20 years30 yearsRemaining time until final repayment due date0first23456789January 2018
2nd and 10-year Bond Yield Spread Chart | earnings, monthly figures (percentage points)Difference between 2-year and 10-year bondsoutput, monthly figures (percentage points)Depression20182019Year 2020Year 2021Day00.51.01.52.02.5Speed ​​adjustmentcurve2018

In early 2021, the yield curve rose sharply as investors found an uptick in growth and inflation as the economy reopened post-pandemic. The attitude of the Federal Reserve, which has said it will be more tolerant of inflation than in the past, has helped fuel this increase. By keeping interest rates low in the short term, the central bank will allow inflationary forces to take a more unequivocal hold, the argument has run, which could lead to even stronger rate hikes in the future. future.

Since then, the shape of the curve has fluctuated. First, in late spring, yields on longer-term bonds fell as investors returned to the view that long-term growth could end sooner than expected, meaning less monetary tightening. than. At the same time, markets have largely swallowed up the Fed’s mantra that inflation is mostly temporary.

The curve began a new spike in late summer, with the market anticipating that the US central bank would announce a “tapering,” or scaling back, of $120 billion worth of bond purchases every year. months, mainly bonds with longer maturities.

In late September, another flattening wave was fueled by a prolonged period of high inflation, surprising many investors.

In response, markets began to bet that the Fed would have to raise rates faster in the short term, pushing short-term yields higher. At the same time, yields on perennial bonds fell, especially after the emergence of the Omicron coronavirus variant cast a shadow over the economic recovery. The gap between 10-year and two-year U.S. yields tightened in early December to its narrowest level in about a year, before investors began pricing in a strong economic recovery.

For some investors, this latest sideways move is a sign that the Fed will only raise rates by a small amount, given a relatively modest growth outlook over the medium to long term. Others went even further, saying it was a sign that a drastic rate hike would be a “policy mistake” that would hamper economic growth and thus prompt the central bank to cut rates. lower interest rates again.

Meanwhile, skeptics argue that the Fed’s bond purchases – along with quantitative easing programs from other central banks around the world – have distorted the bond market and thus upset the bond market. mix predictability of the yield curve.

Whether that’s true or not, financial market clairvoyants will likely continue to look at the yield curve.

Discover for yourself: hear how investor expectations play out across the US yield curve

Yield on US Treasuries (%) equals Start from

Financial Times chartone year5 years7 years10 years20 years30 yearsRemaining time until final repayment due date0first23456789January 1990

Source link

news7h

News7h: Update the world's latest breaking news online of the day, breaking news, politics, society today, international mainstream news .Updated news 24/7: Entertainment, Sports...at the World everyday world. Hot news, images, video clips that are updated quickly and reliably

Related Articles

Back to top button
Immediate Peak