US bond inversion no reason to panic

Investors should not panic about the US Government’s bond yield curve flip despite the looming recession it signals, JP Morgan Asset Management believes.

The firm’s global market strategist, Kerry Craig, said while the global decline in long dated yields and the US bond yield curve inversion were worrying signs it was “not all-out alarms”.

On Wednesday, Wall Street plunged three per cent following the bond inversion.

Craig noted with more than a quarter of global bonds were trading on a negative yield and many government benchmarks were at record low levels, the negativity on negative yields added to the “growing recession watch chorus”.

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“Today however the yield curve is either very flat or negative in many economies around the world, depending on how you measure it. This suggests little is being priced in by investors for future growth or inflation over the coming decade,” Craig said.

“It also means investors are willing to hold safe assets such as government bonds even with very low expected returns – indicating risk aversion.”

Craig said investors needed to check their portfolios were resilient and while bonds rallied a lot this year and were becoming more expensive they remained an important part of portfolios.

“And the market corrections can also offer fresh opportunities to pick up equities at more reasonable valuations,” he said.

Craig said seven of the last nine times the spread between the US 10-year and two-year bond became negative a recession followed around 14 months after the yield curve inverted. Also, seven of those instances the US Federal Reserve hiked interest rates.

“Rising interest rates lift the yield on shorter duration bonds, while lowering the yield on longer dated bonds as expectations for future growth and inflation fall,” he said.

“Put another way monetary policy dictates the shorter end of the curve and economic conditions impact the longer dated part of the yield curve.

“Eventually the combination of tighter monetary policy and downgrading of the economic outlook inverts the yield curve as markets price for a recession.”

While historical economic data showed that a recession may be looming, markets have changed significantly in the last decade and “yield curve inversion is not the harbinger it once was”, Craig said.