DELPHINE GOVENDER: The new fix – a drama every week
Just what does last week’s crisis – the ‘yield curve inversion’ – mean? And should we be panicking about it more or less?
If there is one thing 2019 has taught us, it is an ability to make our seamless weekly journey from what seems to be one obsessive financial "crisis" to the next.
This is especially true for us as South Africans. If we are still worrying about last week’s issue by the next Tuesday, we feel as though complacency must have set in. So, even thinking about the issue discussed here, just a week after the current obsession began, runs the risk of being outdated.
Last week, world stock markets were rattled by something many people had never heard of: the inversion of the US yield curve.
This inversion is what happens in the bond market when longer-term interest rates (10 years) fall below short-term rates (two years). Last week was the first time in 12 years we’ve seen this: the phenomenon that investors are willing to accept a lower yield on money they risk for 10 years than for two years. At the same time, the long-term 30-year US Treasury yield fell to a new low.
The significance of it all?
Well, yield curve inversion is definitely not a common event. Importantly, it has typically been a seminal early warning sign that a recession is on the way. Over the past 50 years, every persistent inversion in the US was indeed followed by a recession.
Why does inversion happen? The only reason rational investors would accept a lower yield on longer-dated funds is if they believe longer-term interest rates are likely to fall sharply in future. Which is only likely to happen if the US economy slows down.
While the actual inversion itself didn’t last long last week (as of today, the 10-year US bond yield has risen above the two-year yield again), its very occurrence was significant enough to raise several important questions.
The job of professional investors shouldn’t be simply to react, but rather to act with rationality
Such as: is a US recession imminent? What does this mean for global markets, equities and bonds alike? What about other regions — can their growth mitigate the damage? And was last week’s panic the right response?
There are no straight-forward answers. In all probability, the US economy should be poised for a slowdown, or even a period of negative growth, following its longest economic expansion in history, which began in mid-2009.
Of course, the preoccupation with US growth is not surprising, given the US’s impact on the world. But in a post-globalisation era, the future of global economic growth should be of greater concern. Trade tensions, coupled with unpredictable and stubborn political leaders, and deep structural challenges in key regions, leave little scope for positive surprises.
Another important difference this time is the current absolute level of interest rates. Typically the response by policymakers to slowing growth would be to cut rates in the hope of stimulating growth. But such low interest rates across the globe leave little scope for this to happen meaningfully.
Mixed all together, you can see why there’d be cause for concern — but not for panic. To investors who have real expenses and real investment needs, the only thing worse than actually experiencing declining returns, capital loss and deep uncertainty is the sense that the custodians of their savings are not reacting with sufficient anxiety about these weekly crises.
But herein lies the rub. A lack of reaction does not point to a lack of deep concern. However, a herd-like over-or underreaction from market participants can, ironically, cause the exact negative narrative being punted to be realised — whether it’s warranted or not. It becomes a self-fulfilling prophecy.
The job of professional investors shouldn’t be simply to react, but rather to act with rationality. Of course, at a time of heightened emotion, rational responses can be seen as being in a state of denial.
But there are no responsible market participants who view current events as trivial. Rather, they seek to make sense of how these important markers might materially change long-term expectations — not just create excessive panic for the week ahead.
• Govender is chief investment officer of Perpetua Investment Managers