Dollar weak as U.S. Treasury yield curve inversion sparks recession fears

07 December, 2018, 19:08 | Author: Brooke Harris
  • Scott Olson  Getty

This has spooked some people, because an inversion in the yield curve is sometimes regarded as the harbinger of a recession. On Tuesday the yield curve signaled caution and, along with worries about global trade and interest rates, it helped send the stock market to one of its worst days of the year.

That boosts the cost of borrowing for American households, and in turn pushes short-term Treasury bill rates higher, while putting downward pressure on long-term rates. It was still positive on Tuesday at 0.12 percentage points.

Gundlach said the Fed will need to be especially careful in its choice of words when they meet this month to deliver on their promised rate hike. That remark appeared to backtrack from a previous statement by Powell in which he said rates were still a "long way" from the targeted neutral rate.

Earlier this week, interest rates on 3-year Treasury notes turned higher than 5-year rates for the first time since the dawn of the previous USA recession, back in 2007.

The Fed's target inflation indicator has held stable right around the two percent target, while the recent plunge in oil prices by more than 30 percent has eased fears of spiraling price increases.

Along with the renewed narrowing of the yield curve, economists on December 3 were parsing a conflicting set of new data. In a flat yield curve, there's little difference between short-term yields and long-term yields. "We are following a strategy and taking account of data over time as it comes in and in response to significant changes in direction".

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Regardless of other possible reasons, "it is mainly indicative of worries about how long growth in the US can remain so strong". A hint at rate cuts coming down the pipeline would offer much needed breathing room for emerging market (EM) currencies and move funds from US government bonds to other havens of interest returns causing them to appreciate against the dollar.

Though it is not certain the narrowing in spreads is related to doubts about economic growth, alternate explanations would not necessarily be helpful to the Fed either.

The gap between two-year and 10-year German bond yields tightened to 86 basis points, after the spread between two-year and 10-year U.S. Treasury yields narrowed overnight.

Italian bonds extended their rally, with two-year yields falling 10 bps to 4 1/2-month lows after a cabinet official raised hopes that the government could cut almost four billion euros from its 2019 budget plans. However, when investors expect interest rates to decline in the future - typically because of a weak economy - they scramble to lock in today's comparatively high interest rates for as long as possible. On Monday of this week, the USA government's five-year bond yielded less interest than the three-year bond.

Markets are also bracing for more news on Brexit.

The outlook for USA growth, by contrast, he said remained strong. The interest rate on 5-year treasuries fell slightly below the interest rate on three-year treasuries.

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