Noble Apex eNewsletter Issue 801-Why should we care about inverted yield curve?

2019-03-25 08:34
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25 March 2019 Issue 801

Global Market Commentary


  • US: A new round of trade negotiations between China and the United States is about to start. US trade negotiator Wright Heze and Treasury Secretary Steven Mnuchin are scheduled to visit China from March 28 to 29, while Chinese Vice Premier Liu He will visit the United States on April 3. Over the week, the Dow fell 1.34% to 25,502.32 points. The S&P 500 index fell 0.77 percent to 2,800.71. The Nasdaq fell 0.60% to 7,642.67.
  • Europe: The EU agreed to postpone the Brexit date until April 12, but if the British House of Commons reach a Brexit deal this week, the Brexit date can be further delayed until May 22. For the whole week, the UK’s FTSE 100 index fell 0.29%, the German DAX index fell 2.75%, and the French CAC40 index fell 2.50%. The STOXX 600 index fell 5.07% for the week to 376.03 points.
  • Asia: As the Bank of Japan starts reducing its bond purchases, the bank’s market share in the Japanese government bond market fell from 43% to 42.99%, the first decline since Haruhiko Kuroda becomes the Governor. Over the week, the Nikkei 225 index rose 0.82% to 21,627.34. The MSCI Asia Pacific Index rose 1.52% to 161.36 points.


  • US: The yield curve between the 3-month and 10-year Treasury yields became inverted, the first time since 2007. For the whole week, the yield on the US 10-year government bond fell 15 basis points to 2.432%.
  • Europe: European Central Bank official Rehn said recent indicators showed a marked decline in economic activity. For the whole week, the German 10-year bond yield fell 10 basis points to -0.016%.


  • Oil: The OPEC+ Committee reiterated its commitment to reduce production, but acknowledged that it would postpone until June to decide whether to extend the period of production cuts. Over the week, New York oil futures rose 0.37 percent to close at $59.04 a barrel.


  • US dollar: The Fed’s March meeting on interest rates showed a dovish signal that it would not raise interest rates this year and would stop shrinking in September. For the entire week, the Dollar Index rose 0.058% to 96.651.
  • China: Chinese President Xi Jinping and Italian Prime Minister Conte signed a “One Belt, One Road” memorandum in Rome. Italy is the first country to participate in the Belt and Road. For the whole week, the yuan rose by 0.010% against the US dollar to 6.713.


Economic-related News

  • US: The number of initial jobless claims in US fell to a four-week low, which was more than expected, indicating that the job market has tightened further after the government’s lockout.
  • U.S: US President Trump said he will maintain tariffs on China until he confirms that China has complied with any agreement between the two countries.
  • U.S: Former New York Fed President Dudley expected that the US economy will be quite weak in the first quarter, but if the economy accelerates again and inflation starts to rise, it may re-tighten the policy later this year.
  • Euro-zone: The Bank of England kept interest rates unchanged and maintained a wait-and-see mode in terms of policy.
  • Euro-zone:EU officials said the EU is preparing to complete the EU-China investment agreement by 2020, and the EU hopes to cooperate with China to save the WTO.
  • Euro-zone: The Speaker of the House of Commons of the United Kingdom refused to re-elect a parliamentary vote on Teresa May’s Brexit agreement, which announced that unless May made a major amendment to the Brexit agreement, it would not conduct a third vote.
  • Japan: Japan Machine Tool Builder’s Association (JMTBA) announced that Japan’s final value of machinery tools in February this year confirmed that the year-on-year decline continued to expand to 29.3% (previous value fell 18.8%), and has recorded a year-on-year decline for the fifth consecutive month.
  • Japan: Japan’s Ministry of Economy, Trade and Industry announced that after seasonal adjustment, Japan’s industrial production index in January was increased by 0.3 percentage, fell by 3.4% month-on-month (previous value continued to drop by 0.1%), which is still the worst since January last year.
  • Japan: The Japanese financial market will be closed from April 27 to May 6. In the face of the longest holiday period for 70 years, the country’s major insurance companies are taking measures to prevent sudden changes in the yen during the holiday period.


China Market Commentary
Economic-related news
• According to a quarterly survey by Bloomberg, the growth trend of A-share are expected to turn slower, and the second quarter’s gains may slow down. The median forecast for the Shanghai Composite Index at the end of the second quarter is 3,200 points.
• The State Council of China has clarified the supporting measures of VAT tax reduction , decided to extend some of the tax incentives that have expired, and granted tax incentives to third-party enterprises, which promote poverty alleviation and pollution prevention.

What should we care about inverted yield curve?

The spread between yields on Treasury bills and the 10-year note, a closely watched signal for the health of the economy, inverted for the first time since 2007 on Friday after US PMI manufacturing data missed estimates. What is there to say about the inverted yield curve?

Inverted yield curve is a reminder that cycles end

The world’s biggest bond market is calling for an economic downturn in US future. When this is the first time the curve has been inverted since 2007, during the last cycle, the spread first fell to below zero in January 2006, almost two year before the start of recession. If history repeats, that means economy will be slump for late 2020 or early 2021.

However, it seems to a lot of time for risk asset to outperform or the economic outlook to improve. What’s more, the median projection of policy makers dropped to zero, compared to additional 4 times after first inversion in 2006. The Fed decision last week to call an end to interest rate increases suddenly can also stop economy hard landing.

Beware Misreading Inverting Yield Curve

Yield curve inversions are unusual because money lenders are willing to earn less interest income for longer. This typically happens when investors expect yields on shorter-term will fall because of Fed rate cut, and dragging down on long-term bonds. It is more likely that economy is slowing sharply and faces a recession risk.

But the pessimism about growth ignores the fact that strong labour market will continues to support consumption. It is true that government shutdown and trade war hurt economy sentiment in Q1 this year. But it is too early to draw a conclusion that US face a recession. Government investment, modest inflation, dovish Fed and tight corporate bond spread will support US economy.

Can Emerging Market benefit from that yield curve?

Inverted yield curve can be no big deal or even good news for Emerging Markets. It is a strong sign that Fed policy is too tight. It is no surprise that Emerging market favour that yield curve.

But the most important question why emerging market bonds have rallied so fast this year. The dovish Fed can be one important reason. But China policy has been another major catalyst. At the beginning of 2019, China central bank cut RRR ratio. Traders now bet that China is opening its liquidity taps again.

The question of the Emerging market future is credit cycle in China. The first month of total social finance is big enough, but Lunar New Year distort the first two months data. At this point, everyone is waiting for March data released in April. The data will show investors direction.

Last but not the least, investment sentiment is also important. The more people misread the yield-curve inversion as a signal of looming recession, the more stocks are likely to fall and volatility to rise, and the greater the risk of pockets of market illiquidity. All of these, if sustained, could dampen household and business confidence, postpone business investment decisions, and pull the rug out from under growth.

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