Yield Curve Screams Recession As Trump Screams At China

Over the weekend, we warned that with the bond market “on the boil”, you were likely to see more “raging rates” moves in the week ahead considering the rapidly evolving outlook for Fed policy in light of the latest trade escalations.

Obviously, Monday’s “shocking” slide in the yuan and attendant cross-asset insanity was gas on the fire and has, in fact, led to more eye-popping moves in the rates space.

10-year yields plunged anew, diving 11bps to 1.73%, the lowest since October 2016. Last week’s 23bp rally was turbocharged as UST futures surged on the back of the yuan news. At one point Monday, the 3m/10y curve was inverted to the tune of 32bp.

That’s the most since before the crisis and it virtually screams “recession”.

Recall the following from a March Deutsche Bank note:

Figure 1 is the [3M-10Y] curve 18m before [an] election. The x axis shows the 10y minus 3m yield curve in basis points. The dots on the positive side of the y axis are labeled with the President’s name, and occurred when the President of the same party as the previous term was elected — i.e. the incumbent’s party won again. The dot on the negative side of the y-axis, are elections where a President from a different party to the incumbent President won the election. The red dot is the median for each occurrence — when the incumbent’s party won again, and when they lost.

The straightforward takeaway is that the red dots (i.e., the medians) do in fact suggest that a flatter curve 18 months prior to an election “implies some greater propensity for the curve to foretell a change away from the incumbent President’s party”, to quote Deutsche’s Alan Ruskin.

Meanwhile, 2-year yields dove 13bps on Monday and a series of familiar trades and dynamics unfurled.

“Red Eurodollars exploded higher once again as the cross-asset hedge of choice with Z0 +17bps at the highs of the session, the largest cumulative 3-day upside move since 11/01/11 at +3.5 standard deviations”, Nomura’s Charlie McElligott wrote early Monday, documenting the mad scramble, and flagging “across the board” receiving.

This is a redux of similar episodes in June and March. “On the session, 10- and 30-year USD swap spreads [were] tighter by 2.06bp and 3.1bp, reaching as low as -10.7bp [and]-41.4bp”, Bloomberg’s Edward Bolingbroke remarked midmorning, adding that the action was “indicative of negative convexity and gamma hedge-related flows in swaps, triggered by breach of key Treasury yield levels”.

It’s also worth noting that the 3-month/5-year curve is now back near the most inverted of the cycle.

Earlier this year, Duke’s Cam Harvey (the “OG of yield curve whisperers”), reminded everyone that when the 5-year/3-month curve inverts and stays inverted for a full quarter, it always presages a recession.