It is rare that the U.S. Treasury market becomes a topic of conversation in everyday life. Yet here we are, where friends and family are asking us what is happening in our markets and what it means for the broad economy. In a sense, we as bond investors are starting to feel…popular?
The renewed interest in our work has been driven by the inversion of the 2yr / 10yr yield curve, where the yield on the 2-year Treasury is higher than the yield on the 10-year Treasury. This phenomenon has caught so much attention because of its rarity, and more importantly, its precedent of accurately predicting economic recessions. On that topic, our global strategy team put out a note last week discussing the inversion and how we should be thinking about it in the current economic and market environment (https://www.blog.invesco.us.com/will-the-inverted-yield-curve-lead-to-recession/).
As we determine how to position portfolios, we see certain strengths in the economy. From a top-down view we still believe the Fed is at least neutral (if not accommodating) after a decade of zero interest rates. Fiscal support (government deficits) are at extraordinary levels for a non-recessionary period, banks are lending, the capital markets are open, and unemployment is at a 50-year low.
However, the clouds on the horizon are building. The Fed may have raised rates too fast (a policy mistake), we are seeing negative economic impacts from trade wars, corporate profit growth has slowed, and geopolitical risks are high. Moving forward, we think that watching corporate behavior closely will be important in determining whether this inversion is a false signal or an actual precursor of a recession. As mentioned in the strategy piece we linked above, corporate America has begun to slow capital spending. Should C-Suites also decide to start trimming jobs, the consumer, which has powered through the recent market volatility, could come under pressure. Then all bets are off.
The investment grade bond market is behaving as expected given the recent bout of volatility. Treasuries and other high quality (AA and AAA rated) bonds are performing well, while bonds on the lower-end of the ratings spectrum have come under pressure. Municipal returns have lagged, which is typical when Treasuries have sharp moves, but we expect them to catch up. In all, now is not the time to try and hit home runs. We plan on continuing to collect our coupon payments and watch how this all plays out as we assess current and potential opportunities.
Source: Bloomberg, Invesco