Equity markets have fallen sharply and government bond yields have experienced another large move lower overnight.
The ongoing protests in Hong Kong and concerns about the global economy, reinforced by weak Chinese and European activity data overnight, continue to weigh on market sentiment.
In a possible recessionary warning, the US 2y10y Treasury curve inverted for the first time since 2007, although it has since returned to marginally positive territory. The yen and Swiss franc have outperformed while commodity currencies have fallen.
Yesterday’s risk-on market rally, after the US announced a delay to imports tariffs on certain consumer goods from China, didn’t last long. The three major US equity indices are 2.9% to 3.1% lower on the day, more than reversing the gains in yesterday’s session. There doesn’t appear to have been a precise trigger for the move lower in equities, which has occurred in a reasonably steady manner since the European market opened (rather than a sudden drop).
Weaker than expected Chinese retail sales and industrial production data, the latter revealing the weakest monthly growth rate since mid-2015 (0.2%), reinforced pre-existing concerns about the slowdown in the Chinese and global economies and the growing toll from the trade dispute with the US. In Europe, German GDP fell 0.1% in Q2 – matching consensus forecasts – as the slowdown in global manufacturing and Brexit uncertainty weigh on the German economy, which has now expanded only 0.4% in the past 12 months. Euro-area GDP rose a slightly more respectable, but still modest, 0.2% in Q2. There were fresh calls for German fiscal stimulus to support the economy, with Chancellor Merkel saying “we will react depending on the situation.” Both sets of data were released before the bulk of the move lower in equity markets occurred. Meanwhile, the ongoing protests in Hong Kong and the risk of Chinese military intervention in the territory continue to weigh on sentiment.
Government bond yields have experienced another massive move lower amidst the risk-off backdrop. The 10 year Treasury yield fell 12bps to 1.58% while the 30 year Treasury yield fell 14bps to an all-time low of 2.03%. In a possible recessionary signal, the 2y10y Treasury curve inverted briefly, although it has since returned to marginally positive territory (+0.6bp). The 2y/10y curve has inverted before each of the past five US recessions, with a lead-time between 11 and 23 months and only one false signal (in the 1990s around the time of the LTCM/Russian Debt crisis). Given its historical reliability, it’s a somewhat dangerous game to say ‘this time is different’, although the current environment, with deeply negative bond yields in Europe and Japan, may be spurring investors in those countries to seek yield in the long-end of the US curve, in turn obscuring the underlying macro signal from the curve. Almost 30%, or $15.8t, of the widely followed Bloomberg-Barclays Global Aggregate bond index was now negative yielding as of two days ago. A more sustained period of inversion would present a more worrying signal for the growth outlook.
There were also large moves in European bonds, with the German 30 year bund yield falling 6bps overnight to a fresh record low of -0.19%. The 10 year UK gilt yield fell 5bps to a record low of 0.445% and the UK 2y/10y curve inverted as well for the first time since 2008. The move in Gilt yields came despite a slightly higher than expected UK CPI inflation print, although the market is much more fixated on the risk of a no-deal Brexit than historic economic data at this point. NZ rates should fall to new all-time lows when the market opens this morning. The 10 year NZ swap rate closed yesterday at 1.3% and the 10 year NZGB yield at 1.1%.
The fall in rates and flattening of the US curve has hammered bank stocks, with the KBW index of US banks falling 4%. Investors are concerned about the outlook for net interest margins in a low rate environment and growing recessionary risk, with banks having a leveraged exposure to the economy. All sectors of the S&P500 were in the red overnight. The Energy sector (-3.9%) led declines amidst a 3% fall in Brent crude oil, with concerns around the global economy and a surprise increase in crude oil inventories weighing on prices.
Safe haven currencies have outperformed, partially reversing yesterday’s moves, with the Japanese yen rising 0.8% and the Swiss franc 0.3% stronger. The fall in oil prices sees the Norwegian krona at the bottom of the currency leader board, down more than 1% on the day, with other commodity currencies also suffering.
The AUD and NZD are 0.8% and 0.4% lower respectively, with yesterday’s weak Chinese activity data and broader risk-off environment weighing on the currencies. There was little impact on the AUD from the release of slightly stronger Wage Price Index in Australia yesterday, with the data indicating that Australian wage growth remains stuck at relatively low levels, around 2¼%. The monthly Australian employment release is today. The NZD is trading around 0.6430.
The GBP is unchanged against the USD over the 24 hours, making it the third best performing currency behind the yen and Swiss franc. The speaker of the House of Commons, John Bercow, whose interpretation of parliamentary procedure is seen as key to MP’s looking to thwart Boris Johnson, said he thought it was possible for MPs to stop the UK leaving without a deal at the end of October. Johnson himself claimed a “terrible collaboration” between MPs opposed to a no-deal Brexit and the EU, blaming those MPs of jeopardising his chances of getting a deal. Betting markets have pared back the chances of a no-deal Brexit this year slightly, to a still uncomfortably high 40%.