The yield curve of US Treasury bonds suffered an inversion on Wednesday, spooking equity markets worldwide: the yield on 10-year US government bonds fell below the yield on 2-year paper. Since most economic recessions are preceded by such an odd-shaped graph (implying that longer tenure credit is cheaper than short-span loans), fears of a slump in America have spiked. Yet, one need not to jump to such a conclusion.
For one, an inverted yield curve does not always signal a sharply slowing economy. Many inversions in the past have been benign. For another, and more importantly, this is not the usual case of an economy overheating to push up inflation and the cost of short-term capital. Interest rates are not only low, they are super low, and have been for an extended period, thanks in part to the extra-easy money policy pursued by central banks of the West ever since the Great Recession of 2008-09. Rather, this inversion is about a crash in yields at the long end, a result of a flight of investor funds into safe assets (like Treasury bonds). Demand for safe bonds is so high that the yields of many non-US bonds have even turned negative. This phenomenon is a sign of worries brought on by global uncertainty over the US-China standoff.
While the US has softened its tariff stance against China, the latter appears to have sent out warning flares of currency aggression; few can predict how badly the global economy would be hit if further hostilities break out. Nerves among investors are taut for good reason, but might their own risk-off behaviour send the US into a recession? This is indeed possible, since investor fright can dampen broader economic sentiment, restrain risky ventures and slow commercial activity down. The yield curve inversion is no cause for panic, but it’s bad news nonetheless.