Treasury bond yield curve inversion reaction was overblown
Yet, there is good reason to believe that all this was an overreaction, and not just because the curve had reverted by the end of the week. It’s likely to invert again in the coming weeks and months. Let’s consider now why a panic may not be in order.
The inverted 2-10 Treasury curve would happen if the US economy were to slow markedly. That is certainly true. But it is not the only reason an inversion can happen. Two other reason seem more influential at this stage.
First, expected price appreciation is also a reason for investors to buy bonds even if the yield is low. Indeed, you need only look at what happened last week in Europe, where many bonds Two reason seem more influential to cause inversion of the yield curve at this stage
Expected price appreciation:
This is one of the reason for investors to buy bonds even if the
plunged further down in yield, driving the stock of negativeyielding bonds worldwide to over $16 trillion (Dh58.7 trillion). And such expectations of price appreciation are supported by the high likelihood that a large non-commercial buyer — that is, the European Central Bank — is on the verge of restarting its yield is low that the prices will appreciate on support of non-commercial buyer
More connected:
Bond markets internationally are much more connected than national economies
large-scale asset purchase programme while pushing its policy rates even more negative.
Second, bond markets internationally are much more connected than national economies. As such, what’s happening to US yields is also a function of what’s taking place abroad. This was highlighted last week when the US curve inversion followed the release of disappointing growth indicators from China, Europe and Singapore.
Overblown
These two reasons also distort the traditional US economic signalling function of an inverted yield curve for Treasuries — a hypothesis that was supported by high-frequency data that pointed to a healthy consumer, the main driver of growth in the US.
All this is to say that worries about a US recession this year are overblown. But this is not to say there are no risks to the economy and the markets; and it certainly is not to say that the curve is unlikely to invert again.
Finally, with the corporate sector more exposed, the stock markets will remain vulnerable to global economic weakness, opening up the possibility of a negative wealth effect if holders of stocks feel less well-off and cut back on their spending.
The reaction to the yield curve inversion was overblown. Yet it included an important warning to politicians around the world. And with lower interest rates on longer-term debt, what a great time to initiate infrastructure programmes in both Europe and the US that can help crowd in private sector investment, enhance supply responsiveness and boost demand in a more sustainable fashion.