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Global markets: what an inverted yield curve means

Geopolitical events; Moody’s rate decision to continue driving the rand – analyst.

NOMPU SIZIBA: It’s that time of the week where we catch up on global markets and economic developments. A big deal yesterday and today was the US 10-year bond yield inverting, which analysts say could spell a global recession. Well, to break down what this all means and more I’m joined on the line by Lukman Otunuga, who is a research analyst at FXTM.

Thanks very much, Lukman, for joining us. What’s the big deal about the US 30-year treasury yield dipping below 2%, and why should markets automatically assume that this spells a possible global recession?

LUKMAN OTUNUGA: As we can see, there’s a … risk aversion engulfing the financial markets, and there is this talk about US ….. …… Well, firstly we saw the 10-year treasury breaking below the two-year on Wednesday, and this normally happens, every single time this has happened, a technical recession or global recession has happened. The reason why the 30-year Treasury yield falling below 2% is much talked about is because this is the first time ever. So, normally, when there is uncertainty, investors rush to the bond markets, where increased demand for bonds produces the yields.

But when we have a yield inversion it simply means that the reward for shorter-dated bonds is actually higher than longer-dated bonds, meaning that investors are really concerned about the longer-term outlook. So they’d rather have a payout in the short term. So, every single time this happens, it’s normally a signal that there is a possible recession around the corner.

NOMPU SIZIBA: When it happens, what’s the time frame between that happening and a recession occurring, and where would the recession occur?

LUKMAN OTUNUGA: Well, we all remember what happened back in 2007/8 – I believe it happened a few months before – and that’s when we had the financial crisis then. So, there is no real time frame to it. It’s just the indication that it could be a possibility.

NOMPU SIZIBA: Realistically speaking, Lukman, is there really that much room for monetary authorities around the world to make an impact on any of the news that they make going forward? If we look at Japan, for example, they’re a case in point where they’ve had interest rates down for the longest time, but they’ve struggled to gain any inflationary momentum.

LUKMAN OTUNUGA: Yes, Europe can also be put into this category where interest rates are 0.4%, and their inflation is still muted – about 1.6%. Then all the central banks still have more room to manoeuvre. Look at the Fed. Interest rates are between 2% and 3.5% and China is at 4.35%. So, what I’m thinking is, as all the central banks join the global easing bandwagon they can only hope that lower rates somehow stimulate consumption and protect their economies through this unfavourable global development, because if we do have a situation where, even though central banks are cutting rates and there is still no increase or no improvement in growth, it is very bad news for everyone else.

NOMPU SIZIBA: How do you think it sits with the Federal Reserve when the president of the United States says that the governor there or the chair has no clue?

LUKMAN OTUNUGA: Yes, this just adds to the uncertainty and fuels concern for the central bank independence because you are saying that a president of the United States shouldn’t have any say in the Fed in regard to monetary policy. But then, when we are looking at the US economy, yes, there are more concerns over a recession around the corner. But overall the data from the US is not that bad. For example, today we had retail sales which was 0.7% in July. So when we’re having positive data points like this is there really reason for the Fed to continue cutting interest rates.

NOMPU SIZIBA: Absolutely. Fair enough. Someone can say it’s just one data point but, like you say, even when you look at their job numbers, they are still creating a lot of jobs in the economy. So it seems that US markets today have picked up a little, despite stuff happening in the background, concerns around trade tensions, and so on. I see company results came out for Walmart, and they came out with good numbers. Are these company results merely going to be a distraction, given the fact that you have the trade war bubbling away?

LUKMAN OTUNUGA: Yes, this is merely a distraction. Markets were helped by these positive figures on retail sales. But, at the end of the day, nothing has changed. We still have trade tensions, China made a statement earlier today, threatening to retaliate should the United States move ahead with the tariffs on technology September 1. We still have global growth there. The IMF has cut world growth forecasts four times in nine months with growth probably predicted at 3.3%. There are geopolitical tensions across the globe. We have Brexit in the UK, yield inversions. Really, nothing has changed and I feel when investors come back from the markets over the weekend next week, it’s still going to be risk aversion.

NOMPU SIZIBA: So, just touching on the UK – you’ve mentioned it there – the UK parliament is still in recess. But, of course, the topic on everyone’s mind must be Brexit as October 31 comes ever closer. I saw comments the other day that British prime minister Boris Johnson is keen to get a trade deal with the EU; but is that still on his terms?

LUKMAN OTUNUGA: It’s funny. This is not the first time we’ve had headlines like this. After he became prime minister, he tried to have talks with Brussels, and he was squarely rejected. This is the same narrative, this is something we are going to continue seeing until parliament returns from recess. Based on this, concerns over the UK cashing out on the EU. The day on Halloween is still a main theme that will continue hitting the British pound.

NOMPU SIZIBA: And where is the British pound these days?

LUKMAN OTUNUGA: The British pound is not in a good place. If you look at the pound/US dollar, it’s now in the 1:22, 1:21 region. The euro/pound actually hit at 10-year high earlier this week. So, and I have said this many times, I won’t be going anywhere during the summer break. I’ll stay in the UK.

NOMPU SIZIBA: I understand that. With the continued level of uncertainty that you’ve highlighted, do you think the gold price is likely to hang on around those US$1 500/oz, given the fact that we don’t know what’s going to happen in future?

LUKMAN OTUNUGA: Certainly. Gold has been incredibly bullish this week and last week, and this is the same theme I’m going to expect in the week ahead. This is the perfect environment for gold. As I said before, if you look at geopolitical risk factors, the fact that we have an inversion in the yield curve, uncertainty across the board and lower interest rates – these themes are going to continue powering gold and if we do secure solid good returns about the $1 500, I believe gold could test 150 and potentially higher in the coming months.

NOMPU SIZIBA: Now we come to the markets, which unfortunately catch a cold when the likes of China and the US do anything. How worried should commodity-exporting markets like South Africa be about the poor showing in China’s industrial numbers yesterday? People are saying it was the worst number in 17 years. Is this evidence of the trade war beginning to bite in that economy, and what can we expect in terms of how that will impact us going forward?

LUKMAN OTUNUGA: Warning signals are certainly flashing red. The poor industrial production levels do signal weaker demand now. Given South Africa’s close trading relationship with China, as its top export destination, South Africa’s exports account for roughly 30% of South Africa’s GDP, and this is incredibly significant. But, then again, I don’t want to be the person that’s just focusing on South Africa. It’s not only South Africa. I would say there are so many emerging market exporters also feeling the heat, and this is a theme that we are going to see moving forward. Looking deeper into South Africa, it’s been an interesting week. We saw the rand weaken to a yearly low, above R15.46 – so wow. Looking at the gains from Monday, it seems that the rand is still trying to fight back. They are actually off roughly 0.3% against the dollar.

In South Africa what’s going to continue driving the rand is not only trade developments, but still speculation of whether Moody’s is going to move forward with that credit downgrade that we are waiting for in November. I’ll be seeing that the South African central bank cuts interest rates because, as we know, low interest rates in South Africa should stimulate consumption at the end of the day and support economic growth.

NOMPU SIZIBA: Let’s hope they do cut. We’ll be very happy with that.

LUKMAN OTUNUGA: This cut will be good for consumers. All of a sudden, you have more disposable income, and you can spend more.

NOMPU SIZIBA: Our thanks, sir, for your time this evening.

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