The bond market is trying to push the Fed into a new rate-cutting cycle
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Plunging Treasury yields are stoking new fears about an economic slowdown, or—depending on which part of the interest rate curve is being scrutinized—an outright recession.
An inverted yield curve — in which rates on short term debt overtake longer-dated paper — temporarily upended markets earlier this year. Over the last month, the turmoil has reasserted itself in stocks as the U.S. and China dig in their heels in a bilateral trade dispute, sparking concerns over a global slowdown.
With the 10-year Treasury yield sinking to its lowest in nearly 2 years below 2.3%, and President Donald Trump threatening to slap tariffs on Mexican imports, economists are split on whether bond investors are reacting to headlines, or fearful of an impending recession.
Yet some think markets may have an ulterior motive: To force a studiously neutral Federal Reserve off the fence, and into a new rate-cutting cycle.
“Treasuries are rallying not because of Fed action, but because people are concerned about trade war escalation” and weaker growth worldwide, said Eric Stein, co-director of global income and a portfolio manager at Eaton Vance, which has more than $493 billion in assets under management.
The Fed meted out its last interest rate hike last December, and has been on hold ever since.
Nevertheless, “the markets are pricing in a significant probability of a fed cutting cycle,” Stein said — an unlikely scenario for now, given a robust jobs market and U.S. growth that checked in above 3% in the first quarter.
‘Kicking and screaming’ into a rate cut
Fragile sentiment and fears of the U.S.-China trade dispute cascading across the global economy has sent investors scrambling to the relative safe-haven of bonds.
That shift picked up speed on Friday, as stock markets convulsed in reaction to Trump threatening Mexico for not doing more to stop the flow of migrants streaming across the border.
Year-to-date, investors have plowed $236 billion into bond funds, while shifting $121 billion out of equities as the S&P 500 (^GSPC) the Dow (^DJI) and the Nasdaq (^IXIC) have tumbled sharply, according to Deutsche Bank data.
Although the Fed has not suggested an imminent rate cut — a move demanded by Trump to help him prevail in the Sino-American trade war — the central bank is certainly paying attention.
On Thursday, Vice Chairman Richard Clarida said the central bank thought the economy was in “a good place,” but could cut benchmark rates if growth slowed sharply.
“The Fed may think they have rates in a good place, but the world is not in a good place,” warned Chris Rupkey, chief financial economist at MUFG Union Bank, who said Trump risked “turn [ing] the world upside down” with his threats of tariffs against major U.S. partners.