Markets were rattled in yesterday's trading as fears of a looming global recession mounted when a key part of both the UK and US yield curves inverted. The yield curve plots the yield investors will receive by holding government debt across multiple maturities. Under normal circumstances, longer maturities yield greater returns than shorter maturities. When the yield curve inverts, it implies that markets are expecting future interest rates to fall, which typically occurs during economic recessions.
Yesterday, the yield on holding a 10-year government bond dipped below the yield on the two-year alternative in both the UK and the US. While the three-month and 10-year yield has been inverted since March, the latest inversion is a significant psychological barrier for investors. The event rippled through other markets triggering a sell-off across major equities and an uptick in safe-haven currencies such as the Japanese Yen and the Swiss Franc.
Fears of an imminent global recession are not new to markets. This year, economic data has consistently disappointed, particularly in the supply-side sectors of Europe and China. As a result, many of the world's central banks have shifted to a dovish policy stance. For the moment, yesterday's event is mostly psychological, and while it has historical significance in preceding recessions, it might only take one positive headline to reverse the inversion. Having said that, the longer-term trend of deteriorating economic data is certainly not to be ignored.
Bottom line: Next month, major central banks will update their monetary policy regimes, and the latest market trends cannot be wholly discounted in determining the outcome of interest rate adjustments. Yield curve inversions along with a slew of negative data, certainly mount market expectations for upcoming interest rate cuts. It's now up to central banks to deliver. Still, a big concern is just how effective this would be given that interest rates are already extremely low.
The pair traded in roughly a 50-pip range yesterday as a heavy risk-off tone left most of the activity in the sovereign debt sector. Sterling briefly experienced a bid tone up to touch the 1.21 level after UK inflation beat expectations but found resistance that left it firmly back in this week's trading range.
The upward trend we've seen so far this week continued in yesterday's session, and the pair has now regained 1.0% of its value since touching almost decade lows. A contraction in German GDP growth and political issues in Italy are contributing to a sell-off in the Euro as the trade-weighted index has been trending lower in recent days.
Fears of a German recession outweighed US-China trade war concerns, keeping a lid on the upside for the pair. The Euro has broken comfortably back through the 1.12 level against the Dollar as expectations for a dovish ECB mount. There's no data released from the Eurozone today so US Retail Sales and the Philly Fed Manufacturing Index will provide the catalyst for any price action.