The US Federal Reserve's dovish turn has probably delayed the arrival of a key bond market recession indicator to 2020, a bit later than predicted three months ago, according to the latest Reuters poll of bond strategists. Only about one-fifth of those answering an additional question expected the gap between US 2-year and 10-year note yields to invert within the next six months, compared to over one-third in the previous poll.
The curve is said to be inverted when shorter-dated maturities yield more than longer-dated bonds, an occurrence in markets which has preceded almost every economic recession since World War Two. While the recent move in bond markets was driven by a sudden change in rate expectations from the Federal Reserve - it has signalled no more rate rises this year - a majority said a 2s-10s yield inversion will happen within a year.
Indeed, the gap between US 3-month bill rates and 10-year Treasury yields, which is closely watched by the Fed and increasingly so by market participants, has already inverted. "There is always a lag between the yield curve inverting and the US going into recession, and it is unlikely to be any different this time," said Alan McQuaid, chief economist at Merrion Capital.
Nearly 60 percent of respondents to a separate question also expected the US economy to enter a recession within the next two years, not very different from the previous poll. That lines up roughly with recent Reuters surveys of economists. But not everyone is convinced a US recession is right around the corner.
"The markets are acting as if the Fed's new patient, dovish stance is the harbinger of a recession," noted rate strategists at Morgan Stanley, who argued the recent decline in yields would underpin the economy and spell better days ahead.
"If the yield curve inversion persists and looks like it might be generating enough concern about a recession that it does indeed become self-fulfilling, the (Fed) may need to consider whether its balance sheet plan is flattening the yield curve in a risky way."
Treasury yields broadly in the latest poll of over 80 fixed-income strategists, taken in the past week, were forecast to be much lower in the year ahead than expected three months ago, tracking the sharp decline in yields since then.
The 2-year Treasury yield is forecast to rise to 2.55 percent in the next 12 months from about 2.30 percent now. The 10-year yield is expected to rise to 2.80 percent in a year from about 2.48 percent on Tuesday. That 12-month ahead 10-year yield consensus is a sharp fall from 3.30 percent predicted in December's poll.
But although 40 percent of analysts who answered the inversion question predict it in a year, the overall forecast is still of a steeper curve, not a flatter one: median forecasts show the gap between 2-year and 10-year note yields about 7 basis points wider to 25 basis points from about 18 now.
The latest data suggest US economic growth is slowing, and the boost from tax cuts is fading. Inflation is tame, which along with uncertainty about how the trade standoff with China progresses, has given the Fed room to pause.
"We are forecasting a gradual slowdown of growth ultimately culminating in a recession - and there is also the broader picture for the global economy, which isn't that great," said Elwin De Groot, head of macro strategy at Rabobank.
"Assuming that the Fed doesn't take any further action, you could still see further flattening, i.e., a slight inversion of the US interest rate curve." While 10-year German bund yields were forecast to rise to 40 basis points in a year from around negative 4 basis points currently, it was the lowest 12-month ahead forecast since a September 2016 poll.
With bund yields priced in for a bleaker economic outlook, the bias was towards benchmark yields to rise rather than fall, reflecting some optimism the European Central Bank's more dovish stance may stall a further economic slowdown. But with the total number of negative-yielding bonds globally hitting the highest since September 2017 - touching $10 trillion - the hunt for yield is pushing investors into US Treasuries, keeping yields there from rising.
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