Fall in yield of US 10-year bond signals recession fears

Fall in yield of US 10-year bond signals recession fears
By Chris Flood
Copyright The Financial Times Limited 2006
Published: August 21 2006 03:00 | Last updated: August 21 2006 03:00


Interest rate rises in the US have led a marked tightening in global monetary conditions during the past two years.

Now, the subsequent economic slowdown and fears over the possibility of a recession next year are preoccupying markets. This is reflected in the sharp fall in the US 10-year bond yield since June. However, growth outside the US remains healthy and real global interest rates are still low by historic standards.

ABN Amro's economists warn that markets are underestimating the potential for cyclical upward pressure on interest rates. As global growth remains robust, Robert Lind of ABN Amro says there is a risk that real short-term interest rates and bond yields will have to rise further before they have an impact on economic activity.

"With mounting evidence of intensifying inflationary pressures, markets will have to push up their estimate of the neutral real policy rate," says Mr Lind.

Stephen Lewis of Insinger de Beaufort says the resilience shown by the leading bond and equity markets is probably the result of the persistence of surplus liquidity. Mr Lewis says policymakers have to think hard about the implications of the liquidity overhang and companies could be tempted into unwise spending decisions as a result of inflated asset prices.

In a thin week for data releases, attention will focus on the details of second quarter gross domestic product provided by the UK, Germany and France while there should be more evidence of US growth moderating from the housing market and durable goods orders.

Two German surveys are due this week and should provide evidence of how activity is shaping in the third quarter. The expectations measure of the August ZEW survey of economic sentiment, due tomorrow, is expected to bounce after a sharp fall in July. A rise from July's 15.1 to 20 is expected. The German Ifo business climate survey has risen strongly since last May but is cooling from a cyclical peak. The August survey, due on Thursday, is expected to ease back from 105.6 in July to 104.7.

In the US, the National Association of Home Builders optimism index is down 50 per cent on the same period last year. Existing home sales for July, due tomorrow, are expected to fall from 6.62m in June to 6.58m. US new home sales for July, due on Thursday, are expected to decline from 1.13m in June to 1.10m. Thursday also brings US durable goods orders for July. The headline measure is expected to be affected by weakness in aircraft orders. The core measure (non-defence capital goods excluding aircraft) is trending downgradually.

There was notable weakness in the capital expenditure measure in the August Philadelphia Fed survey published last week that could eventually translate into a further deceleration in durable goods orders growth.

In the UK, the August CBI industrial trends survey, due tomorrow, is expected to show a small drop in business expectations and new orders.

No revisions are expected to UK GDP in the second quarter after the initial estimate showed better-than-expected growth of 0.8 per cent. Consumer spending is expected to rise 0.7 per cent. However, July's retail sales figures were weaker than expected and suggest consumer spending could be soft in the third quarter.