Volatile August leaves US rates low and investors wary of recession

In normal times, the US Treasury market could be described as "stable", "reliable" or even "boring". August, however, was not normal.

Long-term government debt yields in August recorded one of the most dramatic declines in recent history as rising global demand for bonds drove up prices and lower interest rates. .

The yield on 10-year Treasuries, for example, fell by about 50 basis points for the month, from its peak above 2% to its current level of about 1.5%. The last time the 10 – year return experienced a fall of at least 50% during a calendar month was January 2015, which represents one of the largest monthly declines in l & # 39; after the crisis.

The yield on 30-year Treasury bonds fell to a record low of 1.91% on Wednesday, reflecting a similar drop in overseas rates. The 10-year Japanese rate has fallen to a new negative low in three years this week, while the 10-year German and French rates have both hit unprecedented lows and the Italian rate has fallen below 1%. for the first time.

Strategists and economists said that trying to tie volatility in the month of August to a specific event was difficult, but that Washington's decision makers tended to be a common theme. The US-China trade war in particular has worried commentators, who warned that the dispute could last much longer than expected, or even threaten the candidacy of President Donald Trump for re-election.

"I have to believe that the bond market – the long-term – is meeting expectations regarding the direction the economy is going to take," said Bill Poole, former president of the US Federal Reserve in St. Louis. "And there is this interaction between the economy: the way companies respond to business problems and expectations about what Trump will do."

Long-term rates have fallen so much that 3-month and 2-year bond yields have outpaced long-term rates, a phenomenon known as a curve reversal, a sign that many investors think of a possible future. recession.

Bond market movements have tended to coincide with the volatility of the stock market. The S & P 500, down 1.8% in August, posted gains or losses of at least 1% in 11 of the 22 trading sessions of the month.

The concern began on August 3, when Trump announced that the United States would impose 10% tariff on Chinese goods worth an additional $ 300 billion. China subsequently responded by announcing that it would impose new duties on US $ 75 billion worth of goods and that it would take back the US car rights.

The Chinese response provoked Trump's ire on Twitter, where he said on August 23 that he was ordering US companies to "immediately start looking for an alternative to China, including bringing your business back to the home and manufacturing your products in the United States ".

Investors have lost confidence in a longstanding belief known as "Trump Put", a bet that the president would not push the trade war up to jeopardize the US economy.

Poole added that the drop in long-term rates was both justified and understandable given the growing impact of the trade war on real GDP growth.

The drop in long-term rates is "a consequence of the fact that Trump's trade policy has increased the likelihood of a recession," said the former Fed chief. "I do not think you would get anyone to say that trade policy has not changed the likelihood of a recession, I do not know how likely it is, but it is certainly higher than what it is. she was 18 months ago. "

"And there is also this extraordinary uncertainty about what Trump will do next," Poole warned.

These uncertainties were evident in the US bond market and the yield curve which, on Friday afternoon, showed that the yield on the 2-year Treasury Note was still higher than the 10-year yield.

When investors believe the economy is ready for growth, longer-term bonds pay more than one- or two-year bonds. Although the US government's credit is not likely to change between two and five years, bondholders are more compensated for lending to Uncle Sam for a longer term.

This normal upward relationship between bond maturity and yield may, however, change if investors begin to worry about the slowdown in GDP growth. Some pessimistic investors were hopeful that the Fed would have eased its monetary policy beyond the quarter-point cut made in July, both as a means of reducing short-term rates and ensuring Street that the central bank would be fast if the economic outlook deteriorated.

"I was reading price trends all year until August, as the market was saying [the Fed] will make this adjustment mid-cycle and it will work. Or that things are not enough, but that the Fed will take out insurance, "said Priya Misra, head of global interest rate strategy at TD Securities.

Instead, Jerome Powell, the Fed's president, called a simple "mid-cycle adjustment" not to appease the fears of GDP growth and not to delay the flattening of the yield curve. . His speech at the Fed's annual Jackson Hole, Wyoming, symposium did little to light things up, while Powell recalled the central bank's lack of experience in dealing with the shocks that conflicts trade can have on the US economy.

This makes the upcoming industry data – as well as the September 17 FOMC meeting – all the more important, Misra said, citing future manufacturing reports on the state of production of goods from the United States and China.

"If you get very good data – and I'm not just talking about the payroll, it's been good for quite some time … if you find that morale is going up and the payroll remains good, then -being we go back to the 2016 scenario, which was the slowdown in manufacturing then everything became OK, "she said.

But if the data is disappointing and the weakness of Europe begins to weigh on the US figures, "rates fall a lot," she warned. "It's not like we can make all this movement.A little piece of Pandora's Box was opened until August."