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Yield Curve Flattening Goes Global

FTSE Russell

Contributor:
FTSE Russell
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By:

Director of Fixed Income Research

Global government bond markets have seen significant yield compression since the Federal Reserve pivoted to a neutral policy in the fourth quarter of 2018. Yields have fallen further as rising trade tariff tensions and weaker global growth outlook have caused investor risk appetite to diminish in May. A close examination of the impact of the Fed’s pivot—and reduced risk appetite—on bond markets reveals some interesting themes.

One of the most evident impacts of the Fed’s pivot to a neutral stance has been the flattening of the US yield curve, whereby the US 10-year bond yield is now only a few basis points greater than the 2-year yield. As we have discussed in a previous blog, historically a fully inverted US 10Y-2Y yield curve has been powerful lead indicator of US recessions, with a lag of 12-18 months. Furthermore, Chart 1 shows that the flattening yield curve and declining spread between the longer and shorter end of the yield curves has been a global phenomenon, and not confined to the US; a second major theme.

Chart 1: Yield curve flattening in the G4

Source: FTSE Russell. All data as of May 31, 2019. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

The third theme is global yield convergence. Not only do the Australian, Canadian and New Zealand government bond markets all trade below the 7-10-year bond yield of the US, but their yield levels have been converging steadily since January 2017.

Chart 2 highlights both the extent of the bond yield decline in the US-dollar bloc alternatives of Canada, Australia and New Zealand, and the convergence of yields. 

Source: FTSE Russell. All data as of May 31, 2019. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

Similarly, there has been more evidence of yield convergence in the G4 since Q4, 2018, with the disparity between the 10-year UK, German, Japanese and US Treasury yields narrowing since the Fed policy pivot in Q4 2018, and in the latest flight to quality rally in May.

This is consistent with the spreads versus the US being directional. In other words, yield spreads widened as US Treasury yields increased during the Fed tightening between 2015-2018, when other central banks kept policy rates unchanged, at the zero bound, like the ECB and Japan, or raised rates only modestly as seen in the UK. But the spread has fallen as the US Treasury market anticipates Fed easing in 2019-2020, causing yields to decline faster in US Treasuries, relative to German Bunds, Japanese government bonds and UK gilts.

Chart 3 shows evidence of this recent (directional) convergence in spreads.

Source: FTSE Russell. All data as of May 31, 2019. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

Originally Posted on June 12, 2019

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