I am doing my 2019 outlook pieces now. And I plan on making some market outlook comments in the coming days. But, what’s going on in the market right now is equally important.
As the stock market takes a battering due to concerns about Apple and China, it’s worth mentioning what’s going on in the bond market. Yesterday, I noticed that there has been a huge move in the one-year US Treasury. And so, while the yield curve from two to ten years remains upward sloping, the one-ten year spread was coming close to inverting.
The US Treasury inversion
The real action right now is in the middle of the curve, with the one-year the most important facet. I have the 1-year trading at 2.597%. It had been over 2.60% yesterday and on Monday. That is in stark contrast to the 3-month at 2.425% and the 6-month at 2.507%. So the front of the curve is steeply up-sloping as if investors are anticipating more Fed rate hikes.
But, once you move to the middle of the curve, there’s an inversion, and it is growing. The 2-year is almost 10 basis points lower than the 1-year at 2.498%. And the 3-year is another three wide of that at 2.462%, meaning we have 13 basis points of inversion from 1 to 3 years. Afterwards, the curve kinks up slightly to 5 years at 2.476%, with a more meaningful up-slope to 10 years at 2.643%.
Notice however that the curve is inverted by 12 basis points from 1 to 5 years. That’s huge. And we are very close to seeing a 1-10 inversion as well. What this is telling us is that investors believe the Fed will have to start backpedaling sometime in 2020 and that rates will stay low through 2024. Hence the 1 to 5 inversion. And the magnitude of this inversion – up to 13 basis points today – is pretty severe for a period outside of recession.
My view
The yield curve is simply an early warning sign, a canary in the coalmine. It is not predictive because the Fed can take action. But the yield curve is sending an unmistakable signal that the Fed needs to not just pause but stop. Remember, the 10-year hit 3.25% just a couple of months ago.
If the Fed actually does follow through with its two rate hikes for 2019, I believe we could have a recession in 2020.
One more thing here: the yields in Japan and Europe are painting an equally dire picture. Japan’s 10-year is negative at -0.001%. Germany is trading at 0.166%. It was as high as 0.808% in the last year. And all of the Eurozone yields had been trending down, even Italy. Ominously today, Italy’s yields traded up 16 basis points to 2.861% though. And since this is all about default and redenomination risk. it could also be another canary in the coalmine for financial crisis.
P.S. – The US ISM manufacturing PMI came out as I wrote this at 54.1 vs. 57.7. That’s a big miss. And it may be a sign of weakness to come. It’s not just about Apple today. The bond market is telling us that.