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Bonds continue to signal oncoming recession—5 experts react to the warning

Bond market continues to flash recession warning — What five experts say investors should watch
Bond market continues to flash recession warning — What 5 experts are watching

The recession obsession is in full force.

All eyes are on the U.S. bond market with the yield curve — the widely watched spread between 2-year and 10-year U.S. Treasury yields — inverting further this week, a phenomenon many market watchers believe to be a signal of recession.

But not everybody's sold on the idea of an imminent slowdown.

Here's how five Wall Street experts are addressing the concerns:

Victoria Fernandez, chief market strategist at Crossmark Global Investments, pointed out that other recessionary indicators weren't sending the same bearish signals as the bond market:

"We don't think a recession is imminent. Yes, we have this inversion of the yield curve. That's more of a signal that investors think the Fed is not accommodative enough, but I think there's a lot of stuff going into that, mostly being the uncertainty. This consumer is still strong. The fundamentals are really good. Yes, we've had a slowing in manufacturing — we've seen that both globally with the euro zone [purchasing managers' indexes] and here domestically — but, look, durable goods were good this week, regional manufacturing surveys have been really strong, so I don't think we're on the verge of a recession. I think we need to pay attention to what the yield curve is telling us, but I wouldn't trade on the headlines or trade on this inversion at this point in time."

Paul Hickey, co-founder of Bespoke Investment Group, said that in this scenario, the pros of staying invested still outnumber the cons:

"As we see rates come in, what you have to remember is that it's very stimulative for the consumer and for businesses. The average mortgage payment would be down based on where it was prior to the year. It's down by over 15% year to date. Borrowing costs are down by over 100 basis points for corporations. So, those kinds of moves are stimulative. And when you've seen big moves in the Treasury market like we've seen this year — actually, it's the strongest year since at least 1987 for Treasurys — for the remainder of the year, every time we've been up at least 15% in Treasurys, we've seen gains for the remainder of the year in the equity market. So, I think that you have to weigh the pros and the cons, as we always try and do, and the pros are still outweighing the cons by a little bit."

Alan Ruskin, Deutsche Bank's global head of G-10 FX strategy, said the rate rout could actually benefit the broader market for a time:

"What I tend to like to look for is the idea that there's some self-corrective mechanism in place. So, for example, bond yields have come off so sharply by ... say, more than 150 basis points. That's equivalent to net stimulus from the Fed of twice that, roughly a 300 basis point cut from the Federal Reserve. That should feed through to the economy. That stimulus, in terms of the economy taking hold and growth taking hold, should then feed back on to bond yields and bond yields should [go] back up. The problem I think you're finding right now is that the bond stimulus is not really feeding through in a particularly meaningful way into the sectors that it should. … When you look at September and October and you look at the kind of events that are coming up — the Brexit side, the tariffs that we're likely to have implemented at the end of this month, beginning of next month — that clarity that we're looking for in terms of U.S.-China is not likely to be there. Hong Kong lurks in the shadows. So, I think you've got enough global events that are essentially going to keep this thing rolling in terms of global yields generally suppressed, and I think therefore suppressing U.S. yields."

Brian Levitt, global market strategist for North America at Invesco, also said this yield curve inversion might prove to be atypical:

"It's an ominous sign. And cycles end with policy mistakes and inversions of yield curves. Now, just because the yield curve has inverted 4 to 5 basis points, doesn't mean that this cycle has to necessarily end, but what it does mean is we need greater clarity on policy. Now, the usual cycles end … with the Fed raising short-term interest rates above the 10-year [Treasury yield]. This time is different. The Fed is in an easing cycle. But as long as the uncertainty persists around trade and as long as business sentiment, business investment, new orders all slow, the 10-year's going to go along with that. So, what do we need here? We need the Fed to cut interest rates further and we need clarity from the administration. It doesn't mean we need a trade deal tomorrow, but we can't keep going on with businesses not understanding the rules of the game, because if businesses don't understand the rules of the game, it's very hard to put investment into place. And without investment in place, growth slows and yields go first."

RBC Capital Markets' chief U.S. economist, Tom Porcelli, said that even if we do see a U.S. recession, it's likely to be milder than people expect:

"A lot of the same fears that people were talking about even several months ago are still being talked about today. And … we're sympathetic to that, particularly from a manufacturing perspective. We're obviously seeing some signs of stress there, and people keep on asking us, 'Look, if the next recession does come, what could it look like?' And I think '01 is probably a fair way of thinking about that. The '01 recession, of course, was business-led. The consumer came through that completely unscathed, and I think that's a really important idea. Now, let me be clear: I'm not suggesting that we are going to have a recession anytime soon. Actually, it's not part of our base case, not in the immediate term. But I think if you want to understand what the next recession could look like, I think that's probably a pretty good starting point. … This is the most hated economic recovery that I can remember. So … I think it's easy to stay in there. I mean, look … I don't want to gloss over the risks. We get it; there are risks out there. But we've had a manufacturing recession. We had one in 2015. And, again, I think we have to just be cognizant of what are sort of the key drivers of economic activity, and the key driver is almost always the consumer."