Market Comment - Inverted US yield curve – but no recession in 2019 expected

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Last week, the US yield curve inverted for the first time since 2007. Although an inverted yield curve is often seen as a signal of an upcoming recession, ABN AMRO remains of the view that a recession in 2019 is unlikely. Instead, a moderate economic improvement in the second half of the year is expected. As such, the bank takes a stance that is slightly more optimistic than the view currently reflected in bond markets, says Mary Pieterse-Bloem, ABN AMRO’s global head of fixed income.

An inverted yield curve occurs when short-term interest rates rise above longer-term interest rates. Last week, yields on 3-month US Treasuries exceeded 10-year US Treasury yields in the aftermath of a Federal Reserve meeting where Fed policymakers signalled a shift towards a more accommodative stance on monetary policy. An inversion of the yield curve is often seen as an indicator of recession.

Mary Pieterse-Bloem: “By pushing 3-month Treasury yields above the yield level of their 10-year counterparts, bond markets are sending a message: a recession could be in the offing. At this stage, however, we are a little more optimistic than bond markets. We do not expect a recession in 2019. Economic growth is declining, but we expect growth to return to a level close to the trend rate during the second half of the year.”

In an environment of sluggish growth, central banks could be triggered to step up their efforts to support the economy. For Pieterse-Bloem, this means that central bank actions deserve close attention: “The question is: what’s next? Futures markets are currently signalling that the Federal Reserve might cut interest rates by the end of 2019 or early in 2020. That would make sense if the economy were to slip into recession around that time – which is not our expectation.”

All in all, Pieterse-Bloem believes that a balanced approach to investing is warranted: “Recent dovish shifts by central banks have provided strong support for equity markets. But ideally, you’d want equity markets to reflect strong economic fundamentals, whereas current economic momentum is weak. As we are waiting for data to confirm the expected improvement in the second half of 2019, we maintain our neutral stance on equities. This gives us room for manoeuvre when conditions change.”