Treasury Yields Crash – Ignoring Strong Jobs Report
The coronavirus itself is a serious threat to both U.S. and global economic expansion.
It is both a supply and demand shock to global growth as producers face supply-chain disruptions and service and retail businesses see a sharp drop in consumer demand as more and more people self-isolate to protect themselves from the rapidly spreading infection.
But the virus and the global economic shock it is creating are also starting to touch off financial market contagion and volatility, the likes of which we haven’t seen since the global financial crisis of 2007 and 2008.
This additional financial shock adds a new dangerous element to an already uncertain and negative economic outlook, and will likely prompt economic forecasters to embark on another round of global and U.S. GDP growth forecast cuts as the market turbulence and equity market losses continue to mount.
Already it appears the economic and financial market shock from the coronavirus will be far higher than the one we saw from the U.S/China trade war last year, calling for an aggressive monetary policy and fiscal policy response from all the major economies of the world.
For now, the financial market volatility is based on very little hard economic evidence. Indeed, in the United States, the economic indicators continue to beat economists’ expectations.
Just this morning, we received an incredibly strong employment report for February. According to the Bureau of Labor Statistics, total non-farm payrolls increased by 273k jobs last month with payroll gains for January and December revised up by a net 85k jobs. The job growth was strong enough to push the unemployment rate down to 3.5% from 3.6% in January, further tightening the U.S. labor market.
The news was good on the income front as well, as both average weekly hours improved to 34.4 from 34.3 and average hourly earnings increased 0.3% up from 0.2% in January.
But past performance is no guarantee of future results. The coronavirus is propagating quickly into a global economic shock. The Global Markit PMIs for Manufacturing and Services for February dropped to 47.2 and 47.1 respectively, both firmly in contraction territory. The global economic outlook continues to deteriorate. Global GDP growth is now likely to be in the range of 1.0 to 2.0% in 2020, that is down from the IMF’s forecast at the beginning of the year of 3.3% and the 2.9% pace seen last year during the trade war headwinds.
We expect a sharp slowdown in U.S. economic growth in Q2 to around 0.8% with little to no recovery in the second half of the year. U.S. growth will be held up at a meager pace by some consumer spending growth, government spending, and residential construction as mortgage rates hit all-time lows in the second quarter. Investors are rushing for places to hide and so far finding sanctuary in U.S Treasury bonds.
The long-end of the U.S. Treasury yield curve has never been so low, even at the height of the financial crisis and Great Recession.
Fed funds futures are pricing in Fed rate cuts all the way to the lower bound by the end of the year with an implied yield of 0.195%. Our Fed forecast is that we will see another 25 basis point cut from the Fed at their April meeting and another 25 basis point cut at their June meeting. I think today’s employment report was too strong for the Fed to cut again at the March FOMC meeting, given they just did 50 basis points in cuts this week.
Moreover, if the U.S. economic indicators for March and April show growing evidence a contraction is underway or imminent, the Fed will not hesitate to move the Fed funds rate to their lower bound of between 0 and 25 basis points before year-end.
In short, the bond market is already pricing in a worst case scenario, a U.S. and global recession in 2020 with emergency monetary stimulus from the Fed to help cushion the fall. The flatness of the yield curve at the long-end, suggests the market believes the Fed’s efforts to avert a recession will be unsuccessful.
However, more economic data, probably not received before April or May, will be needed to confirm or deny the market’s bearish call. The market recession signal here is quite strong and getting louder by the day. We see growing risk of a U.S. recession as well, and put the probability of a recession within the next 12 months at near 50%.
To learn more, check out this week’s U.S. Outlook.