Brief Macro: US 5Y-1Y Yield Curve Inverts, but 10Y-2Y Suggests US Will Narrowly Avert 2020 Recession and more

In this briefing:

1. US 5Y-1Y Yield Curve Inverts, but 10Y-2Y Suggests US Will Narrowly Avert 2020 Recession
2. Global Capital Flows Show China’s Collapsing Export Markets Could Soon Revive

1. US 5Y-1Y Yield Curve Inverts, but 10Y-2Y Suggests US Will Narrowly Avert 2020 Recession

The 5Y-1Y section of the US yield curve inverted sharply last week (aided by Friday’s weak NFP release), with the 5-year yield 11bp below the 1-year yield of 2.53%. (That yield spread was +1bp a week earlier). An inverted yield curve is a precursor of a recession 12-18 months later, so the probability of a US recession by 3Q 2020 is rising. However, the key predictor of a US recession is not the 5Y-1Y spread, but the 10Y-2Y spread — which remained rock-solid at 17bp last week (having fallen to that level on Monday 4th March from 23bp on Friday 1st March). The key predictor of US recessions has not yet inverted, so the most likely outcome still is that the US economy will weaken, but narrowly avert recession in 2020. 

The weak non-farm payrolls (NFP) report for February 2019 was largely in line with that outcome. Although February’s NFP increase of 20,000 was far below target, January was revised up to 311000, and the 3-month moving average of 186,000 is healthy for this late stage of the recovery. The US labour market remains tight, with the unemployment rate at 3.8% (and the broadest measure of unemployment falling to 7.3% from 8.1% in January). So wages rose 3.4% YoY in February 2019, the fastest during this 10-year recovery. Although the core PCE inflation rate is still tame at 1.9% YoY, wages are likely to exert mild upward pressure on core PCE inflation in the months ahead. But there will be little need for the Fed to raise rates in the next half year. 

The key cyclical component of the economy, manufacturing, lost momentum in February, with the ISM manufacturing PMI weakening to a 2-year low of 54.2, and the forward-looking new orders weakening to 55.5 — a moderation, but not a catastrophic number. December too was a soft month for manufacturing (with new orders at 51.3) so this bears watching. But the cyclical component of the US economy is still likely to be growing at just below potential in 3Q 2019. The ISM non-manufacturing PMI hit a 3-month high of 59.7 and its new orders component soared to 65.2 — suggesting that the services sector in the US remains in rude health. The weak February NFP will likely mean the continuance of mild weakness for the US$ against Asian and EM currencies (less so against the Euro). The US economy remains on course to lose momentum in 2020, growing less than 2% for the year — with 2H 2020 growth likely to be closer to 1%. The US will narrowly avert recession in 2020, but the economy will not be strong enough to ensure Trump’s re-election. 

2. Global Capital Flows Show China’s Collapsing Export Markets Could Soon Revive

• Capital flows are strongly Granger causal
• Gross capital flows lead World shipping activity by 4 months
• Capital flows have been slowly rising since June 2018: in February they jumped
• Reinforces out pro-Asia and pro-China investment message