Aug 15, 2019

Axios Markets

By Dion Rabouin
Dion Rabouin

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Situational awareness:

  • The 30-year U.S. Treasury yield fell below 2% for the first time overnight, trading at around 1.97%. (CNBC)
  • Warren Buffett’s Berkshire Hathaway upped its stake in Amazon by 11% during the second quarter. (Reuters)

(Today's word count is 990, or ~4 minutes.)

1 big thing: The canary in the coal mine

Illustration: Lazaro Gamio/Axios

The Dow's 800-point fall grabbed headlines, but the real warning about the global economy's dire health comes from Europe. The German economy shrank in the second quarter, showing negative growth for the second time in 4 quarters.

Why it matters: Germany is being decimated by the global downturn in manufacturing and trade that has weighed extensively on major exporting countries. The downturn is likely coming for other economies as well, experts say.

  • "Germany is a more export-oriented economy than even China, so in some respects it’s the canary in the coal mine," Milton Ezrati, chief economist at Vested and former economics head at asset manager Lord Abbett, tells Axios.
  • "When people say the U.S. economy can’t continue to grow when the world is in recession, what’s happening in Germany is indicative of the fact that the world is in recession."

The big picture: Germany is the largest economy in Europe and the growth engine of the broader eurozone economy. As such, it was not the only economy to show its suffering Wednesday.

  • The British economy also shrank in the second quarter, as did with Sweden, and the eurozone broadly grew just 0.2%, half its total from the first quarter.
  • China, the world's No. 1 trading nation, also is showing signs of stress. Its industrial output reading for July was the weakest in 17 years and it reported much weaker-than-expected investment and retail sales numbers.

Be smart: In a global economy, “U.S. economic developments affect the rest of the world, and the reverse is also true,” Fed Chair Jerome Powell said last month.

Yes, but: Seema Shah, chief strategist at Principal Global Investors, predicts the downturn could be delayed until 2021.

  • “The US economy is clearly weakening and risks are piling up. Capex will inevitably slow further, but under the assumption that the trade war doesn’t escalate further, it will not weaken so much as to tip the US into recession," Shah wrote in a note to clients.
  • "The Fed pivot in early 2019, global central bank easing, China stimulus and the reversal of its deleveraging process will support the global economy."

Where it stands: The 2 levers that have saved the economy in previous times of crisis look exhausted.

  • Central bankers have clearly gotten the message and are cutting interest rates at a level not seen since the financial crisis. However, studies show monetary policy is not as powerful as it once was.
  • The world is already deeply in debt and democratic institutions are extremely polarized, making government spending more difficult as well.
Bonus: German bonds yield less than nothing
Expand chart
Data:; Chart: Chris Canipe/Axios

The 10-year German government bond yield dipped to -0.656%, a fresh record low that takes its fall this year to more than 90 basis points.

  • That means an investor who bought $100,000 worth of German bunds would receive $99,344 back at the end of 10 years with no interest payments during the 10-year time span.

Why it matters: This is not how bonds are supposed to work.

What to watch: The ECB is widely expected to cut rates this year, potentially driving German bonds even further negative. German Chancellor Angela Merkel has so far refused calls to increase government spending to offset the economic downturn.

  • "It’s true, we’re heading into a difficult phase," Merkel said Tuesday, per Bloomberg. "We will react depending on the situation."
  • Merkel has argued that spending won't help the country because its problems are not a lack of funding, but a lack of skilled labor and a lack of organic consumer demand.
2. Stocks plummet on fears of recession

Axios' Courtenay Brown writes: The Dow Jones Industrial Average fell 800 points — or 3.05% — on Wednesday, after the bond market flashed a warning sign that's predated every recession for the past 50 years.

Why it matters: It was the market's worst day of 2019. The selloff reconciled what have so far been conflicting sentiments between the bond and stock market.

  • As investor optimism has pushed stocks to record highs, the bond market has consistently sent a much more cautious message — that a recession is coming sooner than we think.

By the numbers:

  • The S&P 500 dropped 2.93%, the Nasdaq closed down 3.02%, and U.S. bond yields also extended declines.
  • The 10-year yield fell below the 2-year yield for the first time since 2007 — marking the "yield curve inversion" that spooked investors.

Of note: As the market slumped, President Trump blamed the Federal Reserve for raising interest rates "too much and too fast" in a series of tweets, calling the inverted yield curve "crazy."

3. Fund managers see highest probability of recession since 2011

Investors were nervous about a recession before Wednesday's selloff.

Details: A third of fund managers polled in the latest Bank of America Merrill Lynch survey said a recession is likely to happen in the next 12 months, the highest recession probability since October 2011.

  • However, a large majority, 64%, say a recession is unlikely.

What's happening: Trade war concerns (51%) were the top risk cited by fund managers surveyed, followed by "monetary policy impotence," which remained in the second spot at 15%. A China slowdown and a bond market bubble round out the top 4, each at 9%.

  • Investors are certainly trading as if a recession is coming. U.S. Treasuries (32%) remained at the most crowded trade identified by fund managers, ahead of U.S. tech (19%), growth stocks (15%) and investment grade corporate bonds (12%).
  • “Investors are the most bullish on rates since 2008 as trade war concerns send recession risk to an 8-year high,” said Michael Hartnett, chief investment strategist. “With global policy stimuli at a 2.5-year low, the onus is on the Fed, ECB and PBoC to restore animal spirits.”
4. Negative interest rates come to the U.S.
Expand chart
Data: Bloomberg, Institute of International Finance; Chart: Axios Visuals

Yields around the globe have fallen to record lows, with nearly a quarter of all government bonds holding negative interest rates.

  • "While the vast majority this debt is in the Europe and Japan, over $60 billion of U.S. corporate bonds are now trading at subzero yields," economists from the Institute of International Finance noted recently.

The intrigue: Former Federal Reserve Chair Alan Greenspan even said Tuesday he wouldn’t be surprised to see more U.S. bond yields turn negative.

  • “There is no barrier for U.S. Treasury yields going below zero. Zero has no meaning, beside being a certain level," Greenspan, who led the central bank from 1987 to 2006, told Bloomberg in an interview.
Dion Rabouin