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Bonds: Is the US term spread signalling a recession?

By Alexander Bueso

Date: Sunday 11 Mar 2018

Bonds: Is the US term spread signalling a recession?

(ShareCast News) - These were the movements in some of the most closely-followed 10-year sovereign bond yields:

US: 2.89% (+4bp)

UK: 1.49% (+2bp)

Germany: 0.65% (+2bp)

France: 0.89% (+2bp)

Spain: 1.44% (+3bp)

Italy: 2.01% (+3bp)

Portugal: 1.86% (+4bp)

Greece: 4.18% (+2bp)

Japan: 0.05% (-0bp)

Yields were higher across the board on Friday in the wake of a bumper report on monthly US non-farm payrolls.

Job creation in the US jumped by 313,000 people last month, according to the Bureau of Labor Statistics, alongside upwards revisions to data for the prior two months, easily dwarfing consensus forecasts for an increase of 205,000.

Nonetheless, according to the CME's Fed Watch tool, Fed funds futures were still pricing in just 73.5% odds of three 25 basis point interest rate hikes for over the course of 2018.

On a related note, at the weekend, UniCredit group chief economist Erik F.Nielsen sounded highlighted the multiple recent signals of "problematic" politics around the world turning into action against the backdrop of his anxiety around the sustainability of growth in the US.

Among those signals, he included China's decision to clear the path for president Xi Jinping to remain in power indefinitely, the poisoning of a former spy in the UK and US president Donald Trump's just implemented tariffs on steel and aluminium.

Against that backdrop, he pointed out the conclusions of recent research by the San Francisco Fed into the declining term premium in interest rates. Specifically, if asset valuations were included, then the spread recently crossed a critical threshold consistent with an elevated risk of economic recession in the US.

Excluding asset valuations on the other hand, the term spread "is elevated but comfortably below the critical threshold given that the term spread is not yet close to zero," the researchers said.

And Nielsen said: "And monetary policies will not remain super-accommodative indefinitely. The Fed is now signalling that they may be eyeing four (rather than three) hikes this year, and on Thursday, the ECB toughened their language as part of their communication leading to an end to QE around the end of this year. In my assessment, it is not likely that a forthcoming economic slowdown will be prevented by a reversal of the presently ongoing monetary policy normalisation among the major central banks."


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