Bond curves flash growth warning

As longer-term yields decline.
Image: Brent Lewin/Bloomberg

The collapse in the global sovereign-debt yield curve is accelerating, sending a foreboding signal to central banks that a withdrawal of stimulus risks triggering a slowdown in economic growth.

The narrowing gap between short- and long-term yields — which has been fueled by central banks removing accommodative policies or getting ready to do so — gained momentum Wednesday with UK 30-year rates sinking the most since March 2020 as the nation cut issuance plans and yields on similar maturity US Treasuries falling as much as 11 basis points. Australia’s benchmark curve is at the narrowest since November 2020 on speculation quicker inflation will force the central bank to act.

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The moves come as traders across global markets have been ratcheting up the outlook for policy tightening. The shift may be reinforced after Brazil’s central bank delivered its biggest interest rate increase in almost two decades and with Europe’s policy makers due to meet Thursday.

“Big picture, investors are having to face the prospect of significantly more hawkish central banks dealing with a massive rise in cost-push inflation and subsequently inflation expectations,” said James Athey, investment director at Aberdeen Asset Management. “Central banks started a fire, then poured gasoline on it. Now they need to deal with it.”

In the US, the world’s biggest government bond market, 30-year yields were already sliding this week as pensions ramped up buying. Meanwhile, short-term rates look poised to rise as money-market traders foresee two Federal Reserve interest-rate hikes in 2022 in a bet that inflation pressures won’t ease.

A rally Wednesday drove yields on 30-year US Treasuries below 2% for the first time in a month with the biggest decline since July. That narrowed the gap with five-year yields to as little as about 78 basis points, a level last seen in March 2020.

Australian 10-year yields declined 3 basis points to 1.78% in early trading Thursday with shorter yields climbing after CPI data yesterday showed stronger-than-forecast core inflation. Traders are now betting on the possibility of four rate hikes within a year.

Canada move

Peter Boockvar, chief investment officer for Bleakley Advisory Group, was especially struck by the Bank of Canada move. That “was not expected and reminds us all that monetary tightening is a global trend right now,” he wrote in a note.

In the UK, 30-year yields tumbled to around 1.14%.

The lack of liquidity exacerbated the rate sell-off in smaller fixed-income markets in countries such as Australia, as investors scrambled to price in more aggressive central bank tightening, according to Aberdeen’s Athey. The three-year Australian yield jumped as much as 24 basis points to 1.01% after a government report showed core inflation surged to a six-year high. The yields on the April 2024 note soared to double the 0.1% level that Reserve Bank of Australia aims to target.

Following the Reserve Bank of New Zealand’s hike at the start of October, markets are already pricing for a second hike at the November meeting as it faces pressure to take action in the face of surging consumer prices.

“Central banks are responding more aggressively to inflation,” said John Briggs, global head of desk strategy at NatWest Markets in Stamford, Connecticut. “So markets are pricing in central banks signaling the likelihood of higher rates, and so curves are flattening in response.”

© 2021 Bloomberg

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