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Government bond yields in most major economies worldwide have been flirting with all-time lows in the last few days, indicating that investors are wary of an impending recession.
German and French 10-year bond yields hit record lows this week, both falling into sub-zero territory after comments from European Central Bank (ECB) official and Dutch central bank chief Klaas Knot buoyed expectations for monetary policy easing, with the aim of boosting inflation in the euro zone. Yields were then pushed down further by bets that potential ECB chief Christine Lagarde will maintain a dovish stance to buoy the euro zone economy.
Bond yields move inversely to their prices. On Thursday, the yield on the 10-year German bund, an important benchmark for European fixed income assets and viewed as a safe haven for investors, was down at -0.398%. Meanwhile, French 10-year bond yields had fallen to -0.12%, Belgian 10-year yields plunged below zero for the first time ever, and Italian 10-year bond yields dropped to a 14-month low of 1.67%.
In times of uncertainty and challenging market environment, investors tend to move their investments from perceived riskier assets into safe havens like gold and government bonds. The move highlights ongoing uncertainty for the euro zone’s economy fueled by a slowdown in Germany, growing unease around Brexit and global trade tensions.
Capital Economics’ Chief Markets Economist John Higgins projected in a note Tuesday that even with euro zone bond yields at all time lows, there is still headroom for the rally to continue. Higgins expects the ECB to cut its deposit rate by 10 basis points to -0.5% in September and announce a continuation of net asset purchases in October, while refusing to rule out further quantitative easing (QE).
“Overall, we suspect that investors are yet to price in the size of both corporate and government bond purchases that we are anticipating,” Higgins said. Capital Economics analysts are forecasting that the 10-year bund yield will end the year down around -0.5% and penciled in similar-sized falls across other euro zone “core” government bonds.
Fears of a slowdown
Stateside, the U.S. benchmark 10-year Treasury yield has fallen back below 2%, trading at 1.9532% on Thursday. This despite a brief break higher on the back of a trade truce agreed between the U.S. and China.
Most analysts are also now pricing in two rate cuts from the U.S. Federal Reserve this year. Fed Chairman Jerome Powell has indicated that at least one rate cut may be coming if conditions continue to weaken.
Chief among the Fed’s concerns are slowing global growth, inflation that persistently falls short of the Fed’s 2% target, and the ramifications of tariffs the U.S. and its trading partners, particularly China, have levied on each other. Draghi also recently hinted at ECB easing if euro zone inflation did not pick up sufficiently. Both central bank bosses are confronted by plummeting inflation expectations, sub-par growth and geopolitical paralysis.
Major central banks have taken a U-turn from previously hawkish policy on the back of slow growth, low inflation and political uncertainty, leading investors to steer clear of risky and volatile assets. The Fed, the Bank of England and the ECB all ruled out rate hikes earlier this year.
The latter slashed its growth forecasts earlier this year. The euro zone economy has relied heavily on exports, but with its German engine room showing serious industrial weakness, Italy entering recession and a Brexit stalemate, all compounded by the U.S.-China trade war, investors have grown fearful.
Market volatility peaked in May as the trade war between the world’s two largest economies underwent various phases of escalation and tariff impositions, sparking multiple quickfire sell-offs of risk assets.
The outlook
In June, the World Bank cut its growth projections, with trade and investment growth and volumes coming down in early 2019, along with wage growth and inflation.
The falling cost of capital is causing markets to reprice assets, the result might be a continued move higher as investors “question where neutral rates are likely to settle,” Roger Jones, head of equities at London & Capital, told CNBC. Jones speculated that we would see U.S. 10-Year yields of 1.5%.
“The stock market has been quick to look through the growth slowdown but this could result in a reversal in the positive correlations between bonds and equities,” Jones added.
If the growth environment doesn’t stabilize, there could be significant earnings disappointments for equities, Jones hypothesized, adding that it is “unlikely” that the growth moderation that has been seen since the fourth quarter of 2018 is entirely down to trade wars.
“Thus, the danger is that the industrial slowdown impacts the labor markets and causes a more damaging consumer slowdown,” he said.
“Many investors are now justifiably concerned about the inverted yield curve and the implication this has for growth.”