The sudden frenzy over a bit of the US yield curve is 'whacko'

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  • Part of the US yield curve inverted last week, leading to increased concern that it signals a looming US economic slowdown, or worse.
  • Shane Oliver, Head of Investment Strategy and Chief Economist at AMP Capital, says the attention the yield curve inversion received last week was “whacko”.
  • He says the recent selloff in global stocks is now “overdone”.

Given recent movements in asset prices closely aligned to the outlook for the global economy, concerns about a potential slowdown, or worse, are only intensifying at present.

You name it, markets appear to be fretting over it: trade tensions between the United States and China, particularly in recent days following the arrest of a senior Chinese business executive in Canada, along with spotty economic data from the US, China, eurozone and Japan, have all taken a toll on investor sentiment.

A flattening of the US yield curve is another factor that has received a lot of attention recently, only adding to unease given its strong track record for signalling a looming US recession.

In particular, an inversion of part of the US curve took centre stage last week with two-year yields moving above five-year yields for the first time since 2007.

Prior to the inversion it’s unlikely that many investors had even heard of the 2-year-5-year spread, but suddenly it was being talked about as a potential early-warning signal that darker days for the US economy lie ahead.

While some may think the inversion of this part of the curve is noteworthy, Shane Oliver, Head of Investment Strategy and Chief Economist at AMP Capital, does not, describing its attention as “whacko”.

Here’s a snippet from a research note Oliver released over the weekend:

The sudden frenzy over a bit of the US yield curve is whacko. Prior to the past week I had never heard of anyone focusing on the gap between US 5-year and 2-year bond yields, which has now gone negative. Similar to the Fed’s own research, our view remains that the yield curve to watch is the gap between the 10-year bond yield and the Fed Funds rate and its flattened but is still positive at 72 basis points. And another useful version of the yield curve, in the form of the gap between 2-year bond yields and the Fed Funds rate, is also a long way from negative. Prior to the last three US recessions both of these yield curves inverted, but there were several false signals and the gap between the initial inversion and recession can be long averaging around 15 months. So even if they both invert now a recession may not occur until 2020, and yet historically share markets only precede recessions by around three to six months so it would be too far away for markets to anticipate.

So Oliver is clearly a non-believer about the attention the 2s5s curve has received in recent days. Nor does he think it means a US recession is quickly approaching on the horizon, as highlighted below:

Of course, when investors want to sell they will, and so markets can still head lower until there is a sentiment washout. But our assessment remains that this is overdone, and share markets aren’t going down into another ‘grizzly bear’ market as the conditions aren’t in place for a US/global recession. We haven’t seen the sort of excess in discretionary spending, debt and inflation that normally precede recessions, monetary policy is not tight and the slowdown in growth indicators looks like the short lived shallow slowdowns we saw into 2012 and 2016.

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