US Treasuries soar after factory data heightens recession fears

US Treasuries rose sharply on Friday after a dismal report on the US manufacturing sector heightened concerns about the outlook for the world’s largest economy.

Yields on the 10-year Treasury Note, a measure of global government bond and consumer loan and mortgage markets, fell 0.13 percentage points to 2.88 percent in thin trading for a US holiday weekend. Yields have fallen nearly 0.3 percentage points in the past three days, the largest such move since 2020.

As for equities, US equities ended the day higher, with the benchmark S&P 500 index rising 1.1 percent after its worst performance in the first half of a year since 1970. The tech-heavy Nasdaq rose 0.9 percent.

A closely monitored study by the Institute for Supply Management showed that the growth rate in the US manufacturing sector slowed sharply in June compared to May. At the same time, executives surveyed by the organization indicated that new orders were being submitted to factories and that labor conditions were deteriorating due to long lead times and high prices.

Weaker data, such as Friday’s, worries investors that measures to curb intense inflation by central banks, including the Federal Reserve, European Central Bank and Bank of England, will derail major global economies.

“The ISM report, along with many other company surveys, points to the recent weakening of the economy,” said Daniel Silver, an economist at JPMorgan.

Weak economic data prompted JPMorgan to revise its second-quarter growth estimates on Friday from 2.5 percent to 1 percent.

The Atlanta Fed’s GDPNow model, which incorporates ISM data and a report on Friday’s construction from the Census Bureau, predicts the U.S. economy would contract 2.1 percent in the second quarter. That would be a second consecutive quarter of contraction, a traditional definition of recession.

Line chart of 10-year Treasury yields (%) partially ending US Treasury sell-off

The data also came after automaker General Motors announced a 15 percent drop in quarterly sales.

Last month, the Fed raised its benchmark rate by an extra large 0.75 percentage point to a range of 1.5 to 1.75 percent. Markets expect fund yields to hit 3.3 percent in March, although these forecasts, derived from trading the futures market, were scaled back significantly from nearly 4 percent a few weeks ago.

Declining expectations for rate hikes and the deteriorating economic outlook have pushed US bond yields from recent highs. Two-year yields – which fluctuate with interest rate expectations – have fallen by about 0.6 percentage points from a June high of almost 3.5 percent.

“It’s a continuation of the recession concerns we’ve seen this week. The market is questioning the Fed’s commitment to raise,” said Ben Jeffery, strategist at BMO Capital Markets.

Fed Chairman Jay Powell admitted last week that an economic downturn in the US was “certainly a possibility” and that avoiding it depended largely on factors beyond the central bank’s control.

Line chart of expected average Federal Funds interest rates in March 2023*, showing expectations of a Fed rate hike pulling back from recent highs

Investors can also bet on a less aggressive Fed, believing that higher interest rates are already pushing inflation down.

The five-year, five-year break-even rate — a measure of where the market thinks inflation will be in five years time — fell to its lowest level since January 2022 on Friday. Some of that move was reversed by the end of the year. day.

“The outlook for inflation is rapidly declining. And I think that while we may see a string of sticky numbers on July 13 (the next CPI report), inflation is on the decline,” said Andy Brenner, head of international fixed income at NatAlliance Securities.

A rally in European bonds on Friday also accelerated after the ISM report. The German 10-year Bund yield fell by 0.1 percentage point to 1.23 percent, while yields on British and French government bonds also fell.

“We’re seeing bond demand come back as a haven,” said Aneeka Gupta, research director at ETF provider WisdomTree.

“There are concerns that central banks worldwide, in order to try and tame inflation, are now not just coming up with a soft landing, but pushing economies into recession,” she added. That, Gupta explained, could lead to a “policy flaw that forces them to reverse course” on interest rates.

European equities ended the day more or less flat, with the Stoxx 600 closing 0.02 percent. Utilities, protected from much inflationary pressures, was the best performing sector in the Stoxx 600, up 3.1 percent on the day.

In currencies, the dollar index, which measures the US currency against six others and rises 0.4 percent in times of economic stress.

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