Yields on benchmark 2-year government bonds, trading as low as 26 basis points in September last year, were set at 4.195% – the highest since late 2007 – at the start of New York on Friday. , when traders reinstated Federal Reserve rate hike bets following a series of hawkish comments from President Jerome Powell earlier this week.
This puts the yield gap to 10-year Treasury bills, which were last seen at 3.754%, about 44 basis points, a deeper “reversal” of the yield curve that often signals recession.
According to a study by the San Francisco Federal Reserve, a sustained inverted yield curve preceded all nine recessions the US economy has experienced since 1955, making it an extremely accurate barometer of financial market sentiment.
Yields on US Treasuries have indeed risen more than 110 basis points since August 1, the Bank of America noted in its weekly “Flow Show” report on Friday, helping to put global bond markets in step with theirs. largest annual declines in more than seven decades.
What BofA calls a “bond crash” could “threaten credit events and the liquidation of the world’s busiest deals: long on the US dollar, long on US technology and long on private equity.”
“Real capitulation is when investors sell what they love and own,” said BofA.
Even the Fed’s seemingly singular hope of avoiding a so-called “hard landing” from its fight against inflation – a resilient labor market – is beginning to falter. Weekly jobless claims missed analysts’ forecasts for nine consecutive weeks and climbed to 213,000 for the period ending September 17.
The Fed itself sees unemployment rise to 4.4% by the end of next year, a move it hopes will moderate wage growth and prevent inflation from becoming more deeply rooted in the US economy.
According to FedWatch of the CME group, fixed income traders are also betting on another 75bp rate hike from the Fed in November, while the Atlanta Fed’s GDPNow forecasting tool suggests third-quarter growth slowed to only 0. , 3%.
“It is possible that the unemployment rate could gradually rise and wages cool without a real recession, but it has never happened before,” said Bill Adams, chief economist for Comerica Bank in Dallas.
“Historically, the rise in the unemployment rate of the entity the Fed wants to see has coincided with a recession, which means significant declines in employment, income, output and sales, widely spread across the economy and likely to last. for more than a few months, “He added.
Elsewhere, bond markets are reacting to both slowing economic activity data, which is signaling a near-term recession in Europe and the UK, and to the new UK government’s attention on tax cuts and extra lending to cushion the impact of its cost of living crisis.
PMI readings from Europe, which measure sentiment from business leaders and operational managers in the region, have fallen below the 50-point mark for three consecutive months, including September, suggesting that the world’s largest economic bloc is likely already. in recession.
“The third quarter clearly marks a turning point for the euro zone economy,” said Bert Colijn, senior economist at ING. “After a strong rebound from the contractions caused by the pandemic, the economy is now becoming more severely affected by high inflation at both the consumer and producer levels.”
“The manufacturing sector is bearing the brunt of the problems,” he added. “Supply chain problems continue to disrupt production, but weaker global demand has caused backlogs to drop as new orders are falling rapidly.”
In Britain, Finance Minister Kwasi Kwarteng, in his first budget statement under the leadership of new Prime Minister Liz Truss, revealed plans to borrow an additional $ 80 billion to pay for both tax cuts. that a cap on energy costs for domestic consumers.
5-year government benchmark gilts, the equivalent of a Treasury bond, suffered their largest one-day drop since 1991, as the pound plunged to a new 37-year low of 1.1160 against the dollar. .
“The sell-off of UK assets reflects sheer panic as the new government’s incentive package will not only increase an already sizable debt burden, potentially to unmanageable levels, but it will also increase inflationary pressures,” said Fiona Cincotta, senior market analyst. at City Index based in London.
“The Bank of England, which has been reluctant to aggressively raise rates, will have to roll up its sleeves and fight inflation with larger rate hikes,” he added. “Expectations for a 1% increase in November are already rising.”