If you’ve been watching the news today, you’ve no doubt seen the nearly hourly commentary about the stock markets selling off, largely as a result of an inverted yield curve. There are also some other factors at play which I’ll get to in a minute.
First off, the main story is the continued grinding lower of global manufacturing activity, largely as a result of the US-China trade war. I wrote about that a few weeks ago and the story is still the predominant bearish theme on the global economic stage.
But now there are a few new variables starting with the inversion of part of the yield curve. However, the belly of the curve has actually been inverted in varying degrees since the first of the year:
The left chart shows the difference between the 10/7/5-year and the 3-month treasury while the right chart shows the difference between the 7/5/3-year and the 1-year. Both have been declining since the 4Q18. The left chart inverted at the beginning of the summer while the right chart inverted at the very end of last year.
What does this mean? In an ideal world, the longer-dated debt has a higher yield because it's riskier — if you lend somebody money for 10 years, there is a longer period of time for them not to pay you back. An inverted yield curve means that longer-dated debt has a lower yield than short-term debt. This signals that bond investors think growth will slow in the next 12+ months. The bond market is a slower-moving place but the participants are usually more economically sophisticated, which means they’re more likely to be right about where things are going.
There are three other new wrinkles. First, the UK economy contracted in the 2Q:
“GDP contracted in the second quarter for the first time since 2012 after robust growth in the first quarter. Manufacturing output fell back after a strong start to the year, with production brought forward ahead of the UK’s original departure date from the EU.
“The construction sector also weakened after a buoyant beginning to the year, while the often-dominant service sector delivered virtually no growth at all.
A big reason for the decline is that the first Brexit date pulled economic activity forward, leading to a natural drop-off in activity afterward. However, the Bank of England has noted that policy uncertainty has increased due to Brexit and rising international uncertainty.
Today, we learned that Germany’s economy contracted in the second quarter thanks to a drop in exports:
In the second quarter of 2019, the real (price-adjusted) gross domestic product in Germany decreased by 0.1% on the first quarter of 2019, after adjustment for seasonal and calendar variations. The Federal Statistical Office (Destatis) also reports that Germany experienced a slight decline in economic performance. The first quarter of 2019 showed an increase of 0.4% compared with the fourth quarter of 2018.
Compared with the first quarter, household final consumption expenditure increased, together with government final consumption expenditure. In addition, more was invested than in the first quarter, however, gross fixed capital formation in construction declined. The development of foreign trade slowed down economic growth because exports recorded a stronger quarter-on-quarter decrease than imports.
Finally, today we also learned that China’s growth is continuing to slow: retail sales, industrial profits, and manufacturing are all weakening.
So — why is this happening? The US-China trade war is now the primary reason for the slowdown. It started to hurt to dampening sentiment, which eventually lowered activity, leading to weaker global manufacturing activity.
And I thought trade wars were easy to win.