Treasury yield curve inversion sparks recession fears

A U.S. Dollar note is seen in this

A U.S. Dollar note is seen in this

Economist Will Denyer of Gavekal Research notes that the yield curve has flattened, and eventually inverted, before every USA recession since the mid-1950s (see chart below).

Global equities have been shaken as a flattening U.S. Treasury yield curve fans worries about a recession, and on growing doubts that Washington and Beijing will be able to clinch a substantive trade deal during a temporary cease-fire agreed at the weekend. "It's the what-if scenario".

The dollar trimmed some of its recent losses but remained under pressure on Wednesday, as an inversion in part of the Treasury yield curve raises concerns about a potential United States slowdown. They pay much more attention to the spread between two-year and 10-year Treasury yields. The Great Recession began in December 2007.

No - and that's why this latest flip in yields may not augur recession. This is called an inversion of the yield curve, or at least a small piece of the curve.

Usually it's the other way around, and it means investors are anxious about the short-term health of the economy.

The flattening of the curve gained momentum after last week's signal by the Federal Reserve that it may be nearing an end to its three-year rate-increase cycle.

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Please consider DoubleLine's Gundlach: Treasury curve inversion signal "economy poised to weaken".

As shown above, the market has a 69.6% chance of at least two more rate hikes in 2019.

Hedge funds and other speculators had amassed a record level of bets on declines in Treasury prices through the futures market, with the heaviest bets lodged against 5-year maturities. In other words, bond holders were okay with being paid less to tie up their money longer with the US government.

Whatever the situation with the Fed and the USA markets, emerging markets may be effected even more than the US economy.

Inversion does not imply in and of itself the Fed will not hike.

Earlier this week, interest rates on 3-year Treasury notes turned higher than 5-year rates for the first time since the dawn of the previous US recession, back in 2007.

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The greenback has enjoyed months of unrivaled performance against its peers but that could be undermined by growing concern about slowing USA growth.

Some business sectors like auto and housing are flagging due partly to rising interest rates, while debt-laden companies have raised concerns whether they could keep up with their debt payments as borrowing costs are rising.

"In the initial phase of the inversion of the yield curve markets are anxious and react more aggressively to weak data than to strong data", said Masafumi Yamamoto, chief currency strategist at Mizuho Securities.

"The curve has to invert and it's going to happen sooner than people think".

"My interpretation of the yield curve is that the markets are clearly showing that growth and inflation are likely to slow next year", said Karl Haeling, vice president at LBBW Bank.

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