Macroscope | Here’s why you can’t trust market signals any more
The US ‘yield curve’ is the latest market indicator whose accuracy and reliability are being seriously questioned
Every now and again, international investors become fixated on a topical theme in financial markets.
Over the past several weeks, the flattening of the so-called “yield curve” for United States government debt has become a focal point of market analysis and commentary. The yield curve – the line that plots the yields on bonds of various maturities – has been under increasing scrutiny since November 21 when the spread, or gap, between yields on 2- and 30-year Treasury bonds fell below 1 per cent, or 100 basis points, for the first time in 10 years.
A flattening yield curve is a source of anxiety because it has often been a harbinger of a recession
A flattening yield curve is a source of anxiety because it has often been a harbinger of a recession. While the yield on the interest rate-sensitive 2-year Treasury bond has shot up a further 40 basis points since early March as the Federal Reserve has stuck to its plan to raise rates four more times by the end of next year, its 10-year equivalent has fallen 25 basis points to 2.3 per cent – 70 basis points lower than at the end of 2013 – partly because of subdued inflation. A number of investment banks, including Morgan Stanley, are predicting a “completely flat”, and possibly even an inverted, yield curve next year.
Yet just because the yield curve is flattening does not mean the US is about to suffer a severe economic downturn. In its latest set of forecasts published on Tuesday, the Organisation for Economic Cooperation and Development expects the US economy to expand 2.5 per cent next year, up from 2.2 per cent this year. Meanwhile, consumer confidence in November rose to a fresh 17-year high.
The sharp moves in bond markets this year reflect a variety of factors. These include low inflation, a significant reduction in what markets believe is the “neutral” long-term interest rate consistent with stable growth and inflation and, more worryingly, complacency among investors who may be underpricing the scope for a further tightening of US monetary policy.
The only thing that is certain is that the yield curve is the latest market signal whose accuracy and reliability are being seriously questioned.
Several other market indicators have become poor barometers of future trends.