Bond yields are on a path lower as recessions risks rise: Strategist

Finance / All Analytics 100 Views

The rate rout appears to be relentless.

U.S. bond yields slid again on Friday following a series of yield curve inversions — when 10-year Treasury yields fall below those of 2-year Treasurys, seen by many as a precursor to a recession — that came on the heels of escalation in the U.S.-China trade dispute.

Stocks also responded to the rising tensions, brought about by China's retaliatory tariffs on U.S. goods and furthered by President Donald Trump's call for American companies to move their production out of China.

The major averages all fell substantially, with the Dow Jones Industrial Average shedding more than 600 points by the end of the trading session. Shortly after the close, Trump announced he would raise tariffs on most imports from China.

This all came after Federal Reserve Chairman Jerome Powell's highly anticipated speech at the central bank's annual summit in Jackson Hole, Wyoming, in which the central bank's leader said there was no "rulebook" for monetary policy during trade wars and that the Fed would "act as appropriate" to maintain the economic expansion.

But those words may not have been strong enough to stem the slide in bond yields, says Mark Cabana, head of U.S. rate strategy at Bank of America Merrill Lynch.

"We do certainly see downside risks to growth and inflation and believe that yields will likely need to fall further as a result of that," he said Friday on CNBC's "Trading Nation." "We could see the yield curve invert a little bit more, especially given that the Fed is not really trying to be super aggressive in their easing thus far, and that raises the risk that you'll see growth and inflation expectations fall a little bit further."

Cabana said his firm has "penciled in" a 1.25% target for 10-year yields, which were just above 1.5% Friday evening. And, while lower yields do have the potential to rekindle economic activity, he worried that they'd be falling for the wrong reasons.

But, while it could stimulate activity by lowering borrowing costs, "what it will primarily reflect is that there are real concerns about longer-run growth and inflation, and you will likely see a Fed which continues to act in order to support the recovery, and that means that they will continue to lower interest rates," Cabana said.

"So, we think that rates will be falling not necessarily for really good reasons, but they should help provide a little bit of an offset to the slowing in the backdrop that we envision in the months ahead," he said.

And, with slowdown signals flashing red in Germany, concerns around growth in China, ongoing protests in Hong Kong and the odds of a hard Brexit on the rise, the number of risks out there are only increasing, the strategist warned.

"We've not penciled in a recession yet, but there are certainly increased risks of that," Cabana said. "We think that we will likely see growth slow down, but we're not going to actually see it in contractionary territory. And we do think that the consumer and the jobs market should be resilient enough to prevent a recession, but those risks are clearly rising."


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