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Bond markets remain in focus after recent curve inversion

Economic data for the US is key to how bond yields respond and how this impacts across major markets. The first week of the month is always jam packed with tier one data and this one could be key for the dollar. We look at the impact on forex, equities and commodities.

Last week the US yield curve inverted at a point that will make the Federal Reserve sit up and take notice. The spread between 3 month and 10 year Treasury yields inverted to -7 basis points. Whilst returning to non-inversion, this is a warning sign, suggesting either short term rates are too restrictive and/or future growth expectations are turning negative. Fed funds futures price c. 60% probability of a rate cut by December. Fed research of spreads across the yield curve see the 3m/10yr spread as most accurate in forecasting recessions, calling the past 7 recessions (average time from inversion to recession c. 18 months). This sounds negative for the US economy and should be dollar negative, but despite last week’s curve inversion, the dollar has been strong. There is a big debate over whether “this time is different”. The degree that an expansion of the Fed’s balance sheet to $4.5tr has distorted the curve could be significant, estimated to have depressed the longer end of the curve by between 100 to 150 basis points (suggesting the 10yr should be closer to 3.5%). How much this distortion would be realised with the balance sheet normalisation ending in September this year, is also questionable. The other fact is that traders see the US economy outperforming, especially the Eurozone. The key is to look at key business indicators, such as this week’s PMIs, and confidence both of which have been falling, but are still robust. The dollar is still seen as being at the safer end of the spectrum and if US data disappoints this could drive another deterioration in risk appetite.

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At Hantec Markets Ltd we provide an execution only service. Any opinions expressed by analyst Richard Perry should not be construed as investment advice or an investment recommendation. This report does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. Forex and CFDs are leveraged products which can result in losses greater than your initial deposit. Therefore you should only speculate with money that you can afford to lose. Please ensure you fully understand the risks involved, seeking independent advice if necessary prior to entering into such transactions.