Treasuries are leading a bull run in global bonds, bringing into sight the prospect of benchmark 10-year yields dropping to 2% for the first time since late 2016 as traders ramp up bets on monetary-policy easing by the U.S. central bank.
Escalating U.S.-China trade tensions and faltering global growth have seen U.S. 10-year yields tumble and the gap between 3-month and 10-year yields -- a commonly watched recession indicator -- move to levels last seen in 2007. Some market watchers, including strategists at Morgan Stanley, are now warning that the deepening inversion of the yield curve clearly presages an economic downturn.
Fed funds futures show that the market is pricing in about three quarter-point central bank cuts by the end of next year, while the 10-year Treasury yield on Wednesday slumped below 2.22%. Yields on similar-dated securities in Australia and New Zealand both dropped to records, while those in Japan matched a three-year low of minus 0.1%. Equivalent German bund rates dipped to negative 0.18%, within a few basis points of their 2016 low.
“The overarching theme of slower global growth, inflation not hitting the mark of central bank targets, and the uncertainty of a protracted trade war are all contributing to that rally,” said Tano Pelosi, portfolio manager in Sydney at Antares Capital, which oversees the equivalent of $22 billion. “I can see U.S. 10-year yields heading toward 2% if the pressure from the trade war continues.”
The renewed bout of risk aversion, brought on by U.S. President Donald Trump’s comment that a deal with China isn’t imminent and tensions between Italy and the European Union, reflects increasing bets central banks will cut rates to revive growth. Traders are focusing on a planned meeting between Trump and Chinese President Xi Jinping at the Group-of-20 summit in June, even as recent rhetoric from both sides indicates a hardening of positions.
Treasury 10-year yields slid as much as five basis points Wednesday to about 2.22%, the lowest since September 2017. The spread between U.S. three-month and 10-year yields fell to as low as minus 13 basis points, the most negative since 2007.
Australia’s 10-year bond yield sank to 1.48%, dropping below the central bank’s cash rate for the first time since 2015, while New Zealand’s declined five basis points to 1.7%. Japan’s declined about two basis points.
Bond auctions are illustrating demand for fixed income. Australia’s sale of A$3 billion ($2.1 billion) of 2031 debt Wednesday drew bids for A$10.8 billion, above the A$8.5 billion offered at a similar auction last year. A $40 billion offering of two-year Treasuries on Tuesday was awarded a basis point below the level in pre-auction trading. A sale of five-year securities on Tuesday also stopped through, and the U.S. government is preparing to sell seven-year notes on Wednesday.
“If policy makers just stand by and growth falls too sharply, then 2% could happen” for U.S. 10-year yields, Shaun Roache, Asia-Pacific chief economist at S&P Global Ratings in Singapore. S&P modeling shows the probability of a U.S. recession has risen to 25% over the past few months from about 20%, he said.
Markets are also signaling two to three moves by the Reserve Bank of Australia amid concern Chinese demand for commodities is weakening.
“If the Fed cuts, will they cut by 25 basis points?” said Rajeev De Mello, chief investment officer at Bank of Singapore Ltd., whose base case remains that the U.S. and China will come to a compromise. “Unlikely -- they probably will cut by 50 basis points, and that’s what we’re starting to see priced into markets.”
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