Two key recession signals in the bond markets are nearing crisis levels

new york stock exchange the great recessionDavid Karp/AP

  • The US yield curve stands at just 17 basis points and could become inverted.
  • European government bond yields have fallen close to zero.
  • Both trends have predicted previous recessions.

Two key bond trends are nearing levels last seen during the financial crisis, signalling a recession could be on the cards.

The spread between the 2-year and 10-year US treasury bonds, known as the yield curve, has narrowed to just 17 basis points, its lowest level since June 2007. Further declines would result in an inverted yield curve, with the 2-year bond trading higher than the 10-year bond. That would imply traders believe there is more uncertainty in the two-year timeframe than there is over a 10-year timeframe - a counterintuitive position which suggests the near-term is very uncertain indeed. An inverted yield curve has preceded every recession in the past 60 years.

Meanwhile, European 10-year bond yields are nearing negative territory. This suggests investors are so desperate to hold safe, government-backed debt that they're willing to sacrifice any return and even stomach a loss to own it.

The volume of eurozone government bonds with negative yields reached a nine-month high in January of nearly €3 trillion ($3.4 trillion), or close to 40% of the total value of all European government bonds on the Tradeweb platform, according to Reuters.

German and French 10-year bond yields have sunk below 0.07% and 0.5% respectively, their lowest levels in more than two years. Danish and Spanish yields have also shrunk to about 0.2% and 1.2% each, also two-year lows.

Italian 2-year and 10-year bond yields have fallen to their lowest levels since the middle of last year. And Portugal's 10-year bonds yield just 1.35%, at least a 20-year low.

Falling bond yields in Europe and the prospect of an inverted yield curve in the US could be bad news for the global economy. During the financial crisis, investors took shelter in bonds, while central banks slashed interest rates to boost growth and printed money to buy bonds, pushing up bond prices and lowering yields.

Recent weak economic data from the US and Europe, together with the European Central Bank's promises of further stimulus and pushing back of rate hikes until at least next year, may be having a similar impact on bond markets.

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