Mar 26, 2019

Will the yield curve lead to recession? It really is different this time

Illustration: Aïda Amer/Axios

Yields on 10-year U.S. Treasury notes fell below 3-month Treasury bills on Friday for the first time since 2007, triggering a major recession indicator.

Yes, but: Market analysts have tripped over one another telling us not to worry. This time is different, they insist. And while strategists with high S&P 500 targets are notorious for balking at clear and longstanding recession indicators, they do have a point. Things are different now.

What's happening: Since Friday's yield curve inversion, the market further positioned for a recession or at least something much worse than the slowdown to 2.1% growth the Fed is predicting.

  • "A lot of investors are spooked and really putting on the recession trade, so to speak," Gennadiy Goldberg, interest rates strategist at TD Securities, tells Axios. "The extent to which we're pricing in rate cuts suggests we're pricing something more sinister than just rate cuts."

The big picture: While investors have implored anxious Americans to look to the strong U.S. labor market and solid 2018 GDP numbers, what's really changed is the impact of central banks.

  • "In the past when yield curves inverted it was entirely the result of the perceptions of investors in the financial markets," Bernard Baumohl, chief global economist at The Economic Outlook Group, tells Axios. "Now we have seen central banks become heavily involved in the bond market."

Background: After the financial crisis, the Fed's quantitative easing program saw the central bank tack around $4.5 trillion worth of bonds onto its balance sheet — much of it longer-dated U.S. Treasuries — in an effort to depress yields and support financial institutions.

Fed Chair Jay Powell announced earlier this month that the Fed would stop reducing those holdings once the balance sheet gets to around $3.5 trillion.

  • "There’s still that stock effect of all those assets they purchased that is holding down longer-term yields as a result," Steve Johnson, senior portfolio manager at Silicon Valley Bank, tells Axios.

And it's not just the Fed. The ECB and BOJ both have negative interest rates for some deposits. German and Japanese 10-year government bonds now have negative yields. That's driving a flurry of investors to U.S. Treasuries, which pay significantly more.

Don't forget: There's also the $1 trillion annual U.S. deficit and unprecedented $22 trillion national debt. The deficit is being funded by issuing more short-dated Treasury bills than longer-dated notes, helping invert the curve, Baumohl says.

The bottom line: The yield curve has inverted before the last 7 U.S. recessions, making it impossible to ignore. But the Fed's quantitative easing programs and subsequent stimulus efforts by governments and central banks around the world have distorted markets. It's hard to rely on historical correlations, positive or negative, because we've never seen this before.

Go deeper: Bond yields are at historic lows around the world

Go deeper

Scoop: Top NSC official reassigned to Energy Department amid "Anonymous" fallout

Photo: Mark Wilson/Getty Images

Deputy national security adviser Victoria Coates will be reassigned as a senior adviser to Energy Secretary Dan Brouillette, the National Security Council said Thursday — and a senior White House official said that the administration "rejects" the rumors that she is "Anonymous."

Why it matters: Coates has battled claims that she is the still-unknown Trump administration official that penned a New York Times op-ed and book critical of President Trump.

The Fed may be setting the table for 2020 rate cuts

Illustration: Sarah Grillo/Axios

The Fed looks to be laying the groundwork to lower U.S. interest rates this year, just as they did in April 2019 before cutting rates in July, September and October.

Why it matters: A Fed rate cut makes taking on debt more attractive for U.S. consumers and businesses, helping to juice the economy, but also puts the central bank in a weaker position to fight off a potential recession.

Morgan Stanley to buy E*Trade in a $13 billion deal

Photo: Rafael Henrique/SOPA Images/LightRocket via Getty Images

Morgan Stanley is planning to buy E*Trade Financial Corp. in a $13 billion all-stock deal, the Wall Street Journal reports, with plans to acquire the company known for helping everyday Americans manage their money.

Why it matters: The deal, which would be the largest by a major American bank since the financial crisis, signals Morgan Stanley‘s desire to bulk up in wealth management.