Warning lights are flashing for the UK economy after the government bond “yield curve” inverted this morning for the first time since 2008. An inversion is traditionally seen as a steadfast indicator of an upcoming recession.
The curve is the difference between yields on long-dated and short-dated government bonds.
Yields, effectively the interest investors receive, should be higher on longer bonds to compensate for the risk of locking their money away for a long time.
Yet yields on 10-year UK government bonds, known as Gilts, sank 3.1 basis points (0.031 percentage points) to 0.467 per cent. This was below the yield on the 2-year Gilt, which rose 0.9 basis points to 0.473 per cent.
Yields move inversely to prices. The inversion shows investors piled into long-dated bonds, which are seen as very safe assets, following the news that Germany’s economy shrank in the second quarter and Chinese manufacturing output growth fell to a 17-year low.
It is a sign that investors are buying up ultra-safe assets because they fear for future growth and inflation and foresee lower interest rates to come.
“Data showing that the German economy contracted in the second quarter reignited fears of a global recession, dampening demand for riskier assets such as equities,” said Fiona Cincotta, senior market analyst at City Index.
Neil Wilson of online trader Markets.com said that in the US’s case, inversion has “been a reliable indicator of recession many times in the past… calling seven out of the last nine”.
Yet Thomas Wells, manager of the Smith & Williamson Global Inflation-Linked Bond Fund, said: “An inverted yield curve is by no means a perfect indicator of a recession.”
Many economists believe central banks’ giant programmes of bond-buying, known as quantitative easing (QE), has distorted the bond market.
“In our opinion the risks to growth are now firmly tilted to the downside and this has been reflected by the recent price action in bond and equity markets,” Wells said.
“Even without Brexit, it is clear that global growth is slowing, so the timing of a potential no-deal scenario in October could hardly be worse.”
Main image credit: Getty