DoubleLine's Gundlach: Treasury curve inversion signal 'economy poised to weaken'

Scott Olson  Getty

Scott Olson Getty

"Investors are coming around to our downbeat view of the prospects for the US economy", analysts at Capital Economics wrote on Tuesday, arguing that there was no reason to regard this pending yield curve inversion as different from others.

WASHINGTON-Top U.S. Federal Reserve officials say a strong economy will likely keep their rate increase plans intact, but on December 3 a key signal began to waver that may intensify debate about whether conditions are as solid as they seem.

The flattening of the curve gained momentum after last week's signal by the Federal Reserve that it may be nearing an end to its three-year rate-increase cycle.

The MSCI's all-country index shed 0.5 percent.

Longer-term bonds offer investors a higher yield (or return) than shorter ones, reflecting the risk of tying up their money for years or decades.

"There can't be another screwup like last time, when they dropped "accommodative" but simultaneously characterized the Fed funds rate as "a long way" from neutral", Gundlach said. Inverted yield curves have historically occurred during periods of economic recession.

Instead of just reflecting investors losing faith, Fed officials have argued that the recently narrowing gap between short- and long-term Treasury bonds could reflect long-term shifts in global capital flows, or the fact that all interest rates are lower and more compressed together than they used to be. A survey of supply managers indicated manufacturing output would grow, but the same survey indicated weaker prices; meanwhile, a decline in construction spending led some analysts to mark down their forecast for gross domestic product growth.

"In the initial phase of the inversion of the yield curve markets are anxious and react more aggressively to weak data than to strong data", said Masafumi Yamamoto, chief currency strategist at Mizuho Securities.

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That message, of a Fed committed to a strategy that would not be shaped by short-term data, was echoed this week by Fed vice chair Randal Quarles.

Traders are even starting to bet that the Fed will cut interest rates as soon as 2020.

Though it is not certain the narrowing in spreads is related to doubts about economic growth, alternate explanations would not necessarily be helpful to the Fed either.

But it's worth asking why the yield curve is such an uncanny predictor of recessions (and no, it's probably not different this time).

German 10-year yields slipped to six-month lows of 0.247 percent before rising back to 0.259 percent. They pay much more attention to the spread between two-year and 10-year Treasury yields.

"What sounds good at the dinner table becomes rather hard at the negotiating table - the market now knows how to read Trump, he knows how to create big news at bilateral meetings but then when it comes to the nitty gritty it can be a very different story", he said.

The outlook for USA growth, by contrast, he said remained strong. The same happened with three- and five-year spreads for the first time in 11 years.

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