U.S. Treasury bond yields continued to suggest difficult times ahead for the world's biggest economy, with the gap between short and longer-dated interest rates at the lowest levels in a decade, even as analysts and policymakers question the meaning of one of the markets most reliable recession indicators.
Three-month Treasury bill yields of 2.453% are now trading roughly around the same level as 10-year Treasury notes, following Friday move that saw the latter dip below 2.45%, creating a so-called inverted yield curve, a condition that Federal Reserve studies have show to be a signal for nearly every U.S. recession for the past 60 years. However, while that portion of the curve remains at the flattest since at least 2007, other areas are starting to slope more positively, suggesting the inversion might be more influenced by international capital flows than domestic concerns for a significant economic slowdown.
"History shows that broad inversions are needed to signal recession, and (it's) clear that the current curve does not fit the bill," said Ian Shepherdson of Pantheon Macroeconomics. "Moreover, we're pretty sure that the inversion would not have happened if the Fed had not been so dovish Wednesday.
"The irony here is that the Fed has helped create conditions which have triggered fears about a recession which policymakers do not believe is imminent," Shepherdson added.
That view was echoed by remarks from Chicago Fed President Charles Evans, who told an audience in Hong Kong Monday that the curve's sharp was more a reflection of "a secular decline in long-term interest rates" rather than signal of impending recession.
"Some of this is structural, having to do with lower trend growth, lower real interest rates," Evans said. "I think, in that environment, it's probably more natural that yield curves are somewhat flatter than they have been historically."
Foreign investors are also increasing their holdings of Treasury bonds, according to last available data from the Fed's monthly Treasury International Capital, or TIC report for the month of January.
China, for example, has increased its holdings in each month since November, as has Japan, the two biggest owners of U.S. Treasury debt in global financial markets. French and German investors, as well, have increased their positions since the end of the year, following the end of the European Central Bank's quantitative easing program in December in the search for risk-free yields.
Benchmark 10-year German bund yields traded at a negative yield of -0.003% Monday, the lowest since October 2016, after last week's grim reading of manufacturing activity in Europe's biggest economy.
Bund yields are a proxy for risk-free interest rates in the Eurozone and a key metric for global investor sentiment. Negative yields in such a large market -- BIS data suggests all German-issued debt was pegged at €3.6 trillion last year -- inevitably push investors to search for higher returns in other markets.
Japanese government bond yields are also negative out to ten years, with investors only getting paltry 0.5% return from a commitment to owning 30-year government bonds until maturity.
Bank of America Merrill Lynch estimated Friday that an additional $12.1 billion has flowed into fixed income portfolios this week, and with negative yields in Germany and Japan, and near-zero rates in other developed markets, it's a safe bet to assume much of that cash has found its way into Treasuries.
The collective moves have driven 10-year U.S. Treasury bond prices higher over the past three months, pushing yields from a late December level of 2.8% to today's 18-month low of 2.449%.
Shepherson of Pantheon Macro suggests the capital flows might be a more powerful drive of the U.S. yield curve than the Friday manufacturing PMI reading that tipped the curve into inversion, given the sector's relatively small influence on the broader economy.
"Some 88% of GDP is not manufacturing, and nearly 92% of people don't work in manufacturing," he noted. "It is possible for a manufacturing meltdown to push the economy into recession, but it would have to be a very deep downturn, and the crunch in manufacturing we expect through the first of this year just won't be bad enough or long enough."
The Atlanta Fed's GDPNow indicator, a real-time tracker of the domestic economy, suggests a 1.2% first quarter growth rate, with the Fed's own 2019 projections pointing to a 2% advance for the whole of the year.
U.S. corporate profits, meanwhile, should grow through the second and fourth quarters of the year after contracting about around 1.7% over the three months ending in March, according to estimates from Refinitiv, with further upside potential coming from a U.S.-China trade deal and a favorable conclusion to Britain's current Brexit negotiations with the European Union.