Any way you slice it, the treasury markets are throwing up a flashing warning sign about the economic outlook going forward. The U.S. Government treasury market is on the verge of a yield-curve inversion in which short-term rates rise above long-term rates. Recent price action has also been particularly concerning and could point to trouble ahead.
What’s the Big Deal?
A yield-curve inversion can say a lot about the economic outlook, and longer-term rates falling below shorter-term rates can be an indication of where investors think rates may be headed. For most of the past year, both short-term and long-term rates have been on the rise as the economy showed strength and as employment reached full capacity. Of note, however, is the fact that yields on two-year notes rose the fastest.
What is happening now, however, is not indicative of simply the short-term outlook improving further, but rather the long-term outlook is diminishing. In other words, longer-term rate expectations are falling rather than rising. In a recent article from wsj.com, Paul Hickey, co-founder of Bespoke Investment Group, was quoted as saying “When it comes to an inverted yield curve, anyone who ignores its economic message should do so at their own peril. As far as the market signal and the ultimate timing of any downturn that follow an inverted yield curve is concerned, things are a lot trickier.”
Put another way, now is the time to be paying attention.
The Fed Is Becoming Increasingly Dovish
The Federal Reserve has already taken a decidedly more-dovish tone in recent commentary, and the central bank has already adjusted market expectations for further rate hikes next year. Although the Fed will almost certainly still raise rates once more in a few weeks, another three rate hikes penciled in for next year are unlikely. In fact, markets now appear to be betting on only a single rate hike for 2019. If the economy does in fact begin to contract, the Fed could potentially even have to resort to cutting rates once again.
The idea of rising recession risk and an inverted yield-curve has already begin to damage the stock market which has seen increasing volatility in recent weeks. Yesterday’s drop of 800 points in the Dow Jones Industrial Average may simply prove to be a drop in the bucket if the chances of a recession increase further.
The gold market has been on the offensive lately, and is poised to challenge key overhead resistance around the October highs in the $1245-$1252 region. Declining long-term rates may give investors further reason to buy, as gold not only could rise under such a scenario but there is also less “opportunity” cost of holding the metal in a lower rate environment.
If the current trend of stock market volatility continues, investors may begin to exit the market in droves, and alternative asset classes like gold could stand to see significant capital inflows. The yellow metal may stay on the stronger side of the ledger, and if yields continue to invert it could see significant buying on dips as positive momentum builds and its technical posture becomes increasingly bullish.