As you can probably imagine, SocGen’s Albert Edwards is pretty stoked about the recent rally in rates and the prospect of further downside for DM bond yields. “There is an earthquake happening in government bonds”, he writes, on Thursday.
Ostensibly, recent events suggest his “Ice Age” thesis – a key pillar of which is US and European bond yields diving to previously unseen levels – is alive and well. “We were told this would never happen in the west because policymakers would not make the same mistakes Japan made!”, Albert exclaims, before noting that “with European yields plunging to new negative lows and the US yield curve giddy with inversion, the skeptics are now seriously contemplating the brave new world in which US 10y bond yields fall below zero.”
Indeed, this part of Edwards’s long-standing thesis isn’t much in doubt. Bund yields hit record lows this month and, on Thursday, Aussie 3-year yields fell below 1% for the first time. For Albert, it’s now just a question of “how negative bond yields will go”.
When it comes to what the US bond market is “saying” about the economy, Albert says the recession “rumblings” have “turned into an ear-piercing scream”. He cites 10-year and 2-year yields below the funds rate. We’d remind you that whenever the 2-year rate minus the Fed Fund Rate drops to -40bp, historically the Fed cuts in relatively short order.
That’s something both Goldman and David Rosenberg pointed out recently, and speaking of Rosenberg, Albert cites David, as he’s wont to do.
“David Rosenberg has reviewed the NBER website for the criteria they use for dating the start of a recession and he thinks that the recession likely started in Q1”, Edwards writes, adding that “the latest probability from the NY Fed model has reached 30% but as the NY Fed model only reached a high of 42% during the 2008 recession the deepest since the Great Depression [it’s] reasonable to rescale these probabilities.”
(SocGen)
Rescaling things puts the current probability above 60%.
Albert does remind everyone that “inversion [is] neither a necessary nor a sufficient predictor of recession”, but rather, the post-flat/inversion steepening is what you should fear. “That may be underway”, Edwards says. This is in line with quite a bit of analyst chatter revolving around the notion that investors should “fear the steepener” as a precursor to recession.
Edwards doesn’t bother with a lot of nuance when it comes to parsing the likely path to a steeper curve going forward. “[It] will involve a bull steepening as both 10y and 2y yields decline further, accompanied by cuts in the Fed Funds rate”, he says, flatly.
Finally, Albert points out something that’s been a hot topic of late (or maybe “cold” topic is better in the context of the “Ice Age”). “One key measure of inflation expectations central banks watch closely… have collapsed to shocking new lows in the eurozone!”, he shouts.
(SocGen)
In case it’s not clear enough, the message from Edwards is a familiar one – DM yields are likely headed lower and a recession is probably imminent. In the course of wrapping up his latest, Albert cites a Wall Street Journal survey which points out how wrong-footed analysts’ 10Y yield forecasts look in light of the recent rally.
“One big mystery to me is why bond strategists are so perpetually bearish with not one forecasting the rally so far this year”, Edwards says. “If he US has already slipped into recession, what price on yields heading way below zero before the recession ends?”
