Published: Thu, December 06, 2018
Economy | By

What A Yield Curve Inversion Means For Traders

What A Yield Curve Inversion Means For Traders

US stocks slumped almost three percent on Tuesday on some of the same growth concerns influencing bond investors as well as on doubts China and the United States would resolve their trade spat.

Trump's comments, alongside the drop in USA stocks and bond yields, took Asian shares outside Japan 1.5 per cent lower.

The yield curve measures how much more in interest investors get for owning a long-term Treasury bond than a short-term one. Many market participants are now watching to see how the Fed reacts to that inversion, along with whether the two-year and 10-year yields will also invert. A year ago, the cushion was at 0.62 percentage points.

"The market decline in the USA overnight and the flattening of the yield curve reflect that economic growth momentum is taking over as the primary concern for investors", Tai Hui, a strategist at J.P. Morgan Asset Management told clients.

"Inversions tend not to be particularly dramatic, so the intraday event is more of a technical milestone than breaching a level in outright yields", wrote Ian Lyngen, head of USA rates strategy for BMO Capital Markets.

Global equities have been shaken as a flattening US Treasury yield curve - a result of a steep fall in longer-dated yields - fanned recession jitters and as US-China trade conflict woes resurfaced after a temporary lull.

When yields for short-term Treasurys rise above yields for long-term ones, market watchers call it an "inverted yield curve", and Wall Street starts getting more nervous.

The pound rose off 17-month lows of $1.2659 (GBP=D3) hit on Tuesday to around $1.2751, up 0.3 percent on the day, amid creeping optimism that Britain could opt to stay in the European Union after all.

"The market decline in the USA overnight and the flattening of the yield curve reflect that economic growth momentum is taking over as the primary concern for investors, even as the latest ISM manufacturing data is holding up well", wrote Tai Hui, market strategist at J.P. Morgan Asset Management.

The 3-month to 10-year spread is now 0.492 percentage points. US financial shares, which are particularly sensitive to bond market swings, dropped 4.4 percent.

It has sometimes taken more than a year for a recession to occur after the yield curve inverts.

Early in Asian trade, the yield on benchmark 10-year Treasury notes fell to 2.9661 percent compared with its USA close of 2.991 percent on Monday.

The narrowing spreads between the rates of long and short-dated government debt comes even as stock markets have kicked off the week on a high note, after President Donald Trump agreed to postpone further tariff increases on Chinese imports. A separate spread between 3-month and 10-year Treasury securities, considered by some as a better recession predictor, was also falling, though at just around 0.5 percentage point it remained comfortably in positive territory.

Sterling briefly drooped to a 17-month low on the day, before recovering ground to trade little-changed, in a volatile session dominated by Brexit-related headlines.

The threat of slowing economic activity also weighed on oil prices, but oil prices went higher on Wednesday ahead of a meeting of the world's biggest exporters who will discuss cutting output to help shore up prices and curb excess supply.

US crude was 0.5 percent higher at $53.23 per barrel.

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