If 2019 was the year the yield curve went mainstream, with an inversion sending a stark recession warning, then 2020 is already shaping up as a welcome return to normality.
Nobody is willing to call the all-clear on the global economy yet given a trade deal between the U.S. and China is still to be reached. Even so, the prospect of longer-term yields stretching their premium over shorter maturities is among the top trade ideas for next year on Wall Street, drawing money from the likes of BlackRock Inc., Penn Mutual Asset Management and Aviva Investors.
“The curve, from two- to 10-years, will probably be modestly steeper in most places,” said Praveen Korapaty, chief global rates strategist at Goldman Sachs Group Inc. “This is largely because some of the tail risks that people were worried about have at least reduced. It will certainly be different from this year, where in most parts of the world there was pretty strong flattening.”
A global bond rally this year drove the yield on 10-year Treasuries below those on two-year securities in August, for the first time since before the last financial crisis in 2007, and the last five such occasions a contraction followed. The inversion and a potential recession became a hot topic in Google searches and around the dinner table, yet the economic contraction hasn’t arrived so far after central banks stepped in with more stimulus.
Global share prices also aren’t giving any indication of trouble ahead on the economic front. The S&P 500 Index, Dow Jones Industrial Average and Nasdaq Composite Index all closed at record highs Monday. Japan’s Topix Index touched a 13-month high Tuesday.
History also shows that such inversions can flash “false positives” on the indication of a downturn, and for PGIM Fixed Income’s chief economist Nathan Sheets, that’s the case this time around. While a recession typically emerges about 12 to 18 months after an inversion, Sheets still doesn’t see a downturn in that time frame.
“The global economy has skirted the recession threat,” Sheets said. World economies “have been hit with a broad range of geopolitical shocks and uncertainties in recent years and have just kind of continued to barrel along at what I call mod-lustre –- something between modest and lackluster -- growth.”
The New York Federal Reserve’s recession probability gauge, which uses the three-month to 10-year Treasury curve to predict the chance of a U.S. contraction in the next 12 months, plunged last month. The gap between two- and 10-year Treasuries is now at about 15 basis points, versus minus seven basis points in August.
Narrow Miss
In Europe, Germany narrowly averted a recession last quarter, and its bellwether yield curve has also steepened after coming close to inversion. Growth remains depressed in the U.K. and Japan, whose curves both inverted in August, but since then, long-end yields have risen more than the front of the market.