You can count me as surprised.
But not for why you are thinking – that the ticker tape is
not looking very good now or that safe assets are rallying.
When the two largest economies of the world are firing warning
shots across each other’s bows, that the stock market is reacting ought not to
be a surprise
What I am surprised by is the number of conclusions being
drawn about the interest rates markets on a global basis.
You can’t go to any financial publication without reading
about the blaring signals of an imminent recession that the bond markets forecasted.
The level of interest rates, the steepness of the yield curve—everything
seems to be pointing towards an imminent recession. And thus, the end of the
But if you look a little deeper, it becomes quite clear that
at the end of the day, this, is the ultimate form of confirmation bias.
Some investors and commentators who are convinced that a
recession is imminent are simply going to certain parts of the bond market and
looking for data to confirm their views.
To be sure, the level of yields and shape of the curve, at
various points over the past few decades, have predicted recessions, or, at the
very least, foretold the rising probabilities of them.
But we are in a different inflation and interest rate regime
since the financial crisis. Interest rates on a global basis are being driven
as much by structural disinflationary issues — or deflationary if you want to
be dramatic — around the developed world including liability immunization,
cross-border flows, and policy actions by various central banks who are carrying
out their own political mandates and pressures.
In other words, the US Treasury curve may not be as reliable
an indicator of the potential growth rate of the U.S. economy as it has been in
other inflationary regimes. If you accept that premise, then reading too much
into the yield curve – whether its shape or the level of yields –is an exercise
fraught with the risk of delivering false positives.
You just have to look at the 10-year Treasury yield (TSY)
chart over the past ten years to see the risks.
Figure 1: US 10-Year Bond Yield
We have been here before without any material disaster.
However, there is another part of the bond market that is
far more vulnerable to economic activity and less impacted by global flows and
disinflationary pressure than safe assets are – and that is the credit market.
If things are headed south for the economy in a big way,
credit investors would be hurt and hurt badly. So, credit investors’ views about
the prospects of the global economy should contain as much, if not more, information
than the actions of investors in the government bond market do.
And if you look at the spreads of the US investment grade market—the deepest credit market in the world—you find a very different story than the one US government bonds are telling.
Figure 2: Investment Grade Credit Spreads
Represented by the Bloomberg Barclays Aggregate Credit Index Option Adjusted Spread (OAS)*
Yes, risks have increased as trade concerns have flared up
and spreads have certainly widened. But where is the panic?
The closest we came to a recession in this cycle was when
the frackers blew up in 2015 and 2016 or when the credit markets reacted poorly
to the Eurozone nearly breaking up in 2011.
Nothing even close to that is happening in the credit
Still, I am not dismissing the fact that the price action in
the market is concerning. Nor am I asserting that the drivers of the market at
the moment — like trade – do not have the potential to propel us into a recession
Far from it. If things continue to go down the path of currency wars – that is,
the situation becomes far worse than just trade tariffs – we could get to a
Instead, my point is that you should look at the balance of
evidence from all macro markets – including rates, credit and currencies – to
come up with your prognostication for the global economy. Yes, it is true that
government bond markets are signaling potential issues, but that is not being
corroborated by the credit or currency markets.
Blog header image: Ivy Barn / Unsplash.com
*The Bloomberg Barclays Aggregate Credit Index is designed
to measure the performance of investment grade corporate bonds in the U.S.
Option Adjusted Spread (OAS) is a measure designed to measure the difference in
yield between a bond index and its benchmark (in this case, Treasuries).
The opinions expressed
are those of the author, are based on current market conditions and are subject
to change without notice. These opinions may differ from those of other Invesco
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