Equities markets have hit turbulence today with investors spooked by the yield curves of UK and U.S. government debt inverting. A yield curve inversion is when long term debt such as 10-year bonds offer a lower yield than shorter term debt.
Under normal circumstances, long term bonds offer a better yield than short term bonds because of the theoretical higher risk of locking up cash for a longer time. But this morning the yield on 10-year UK government Gilts dropped 3.1 basis points to 0.467%. That coincided with 2-year UK government Gilt yields improving by 0.9 basis points to 0.473%. The same with happened yesterday between 2 and 10 year U.S. Treasuries.
The last time U.S. Treasury yields inverted was 2007. It was 2008 in the case of UK Gilts and while a yield inversion is certainly not a guarantee of a coming recession, it has in the past proven to be a reliable signal. George Buckley, a UK economist at investment bank Nomura explained just why investors are so concerned this morning:
“Over the past 40 years every recession in the US has been preceded by a curve inversion and there have been no instances where the curve has inverted and there has not been a recession.”
A yield inversion has not been quite such a reliable omen in the UK and has in the past happened, as in 2008, without a recession eventuating. It can be presumed that investors made a leap for the bolt hole of long term government debt yesterday, pushing down yields, on a spate of gloomy economic data. Chinese manufacturing output growth dropped to a 17-year low and Germany’s usually resilient economy contracted in the second quarter.
While certainly something to keep a close eye on, investors would do well not to presume that the current yield curve inversion on both sides of the Atlantic is a bullet-proof argument a recession is inevitably on our doorsteps. While U.S. yield inversions have preceded 7 of the past 9 recessions, it’s certainly not a perfect indicator. Many analysts and economists have also pointed to the fact that the huge central bank bond-buying programmes conducted since the recession as part of quantitative easing strategies to stimulate the economy with injections of cash could well have distorted bond markets.
There are a number of indicators pointing to a slowdown in global economic growth and there are risks to the downside in financial markets. But that doesn’t mean an actual recession is inevitable.Risk Warning:
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