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What yield curves are telling us about recession risks

Key points

  • US growth is strong, inflation is already at target: little to halt the Fed from tightening
  • The Eurozone is finally posting signs of growth stabilising
  • But politics remain a risk, if not a headwind, from Italy to Brexit
  • The recent global equity sell-off, mainly due to technical factors, does not change our moderate overweight in equities
  • We reduce emerging market equities to neutral, in absence of a catalyst for outperformance
  • UST bonds now look more attractive, both as a source of carry and of downside protection against additional market jitters

Although 10 year US treasury yields recently hit a seven-year high, the debate over the implications of US treasury yield curve inversion will come back

The US economy is growing at full speed (business surveys have reached cyclical highs, first in manufacturing and more recently in services) despite being at full employment. Inflation is already at the Federal Reserve’s target level showing convincing signs that nominal wages are accelerating. We therefore see little to halt US monetary tightening. As we expected and witnessed last year (and contrary to 2015 and 2016), the Fed has remained in the driving seat: its ‘dot plot’ forecast of future interest rates has been consistent and market expectations are gradually converging towards its outlook. With one more hike expected this year (December) and three in 2019, the Fed Funds Rate will reach and exceed the neutral rate in the (latter) course of next year.

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