The yield curve recently inverted with the 3-month treasury yield falling below the 10-year. A huge influx of capital has sought to park itself in the 90-day paper, and warnings abound of a coming recession in the US economy. However, because so many of the buyers of US debt now are international, the inverted yield curve is likely now more a harbinger of fear in the global rather than just the American markets.
Europe’s debt problem is massive. Mario Draghi’s quantitative easing program succeeded more to keep Europe’s banking complex propped-up than to stimulate its economies. It also left the ECB holding around 40% of all Eurozone sovereign debt on it book, most of it with paltry-to-nil yields. There is almost no chance that the central bank will receive any bids on it, so it will simply have to hold it with the hopes that those obligations will be made whole prior to maturity. The commercial banks in Europe have forsaken much of their interest in sovereign paper in favor of purchasing real estate and then leasing it out for a 5% yield. For liquidity, they have been lending between one-another to avoid the negative yields they will be charged for parking money with the ECB.
Much of Europe’s economy is still anemic, with unemployment among young adults in some of the southern states still ranging in the vicinity of 50% after 4 years. The political turmoil with the Yellow Vests, Brexit, Catalonia, Germany, and Italy – to name a few – is hardly stabilizing. European peoples’ umbrage towards the governments of their individual countries and towards the EU governing body is largely fiscally-driven. To be blunt, the socialist policies of these governments is finally failing. They have run out of others’ money, but will never admit that. Instead, they are enacting more controls on capital and personal freedoms. All this turmoil has driven a substantial amount of capital into the US where the turmoil has been dramatic in our politics, but relatively mild in our economic matters.
Some fund managers and western governments, unsatisfied with the returns in their developed markets, ventured into emerging markets beginning nearly two years ago. Some did well, but they have lost out on the currency conversion across the board since the rise in the US dollar began at the start of 2018. Now Turkey has trapped external investors by refusing allow transactions out of the Lira. This appears to have spooked investors in other emerging markets, whose currency valuations have become increasingly volatile.
So while none of this is good news, it does fortify the view that the rush into short-term US treasury debt is more than just domestic money seeking having from a coming domestic economic downturn. The jobs and other numbers in the US have weakened recently, but there is still good reason to doubt that a full blown US recession is yet on the way. The US will have to face a comeuppance with its own insurmountable debt burden. But because its economy has been the strongest around with Trump seeking to minimize the taxation and regulation of investment and business, it is providing a haven for worried money for now. Even as the US nears its own insolvency reckoning, it still will likely remain a haven for a lot of global money. However, investors will direct their capital more into the private rather than the public sector. Look for another rise in the US equity markets at that point – one driven not so much by US business fundamentals, but by international money seeking shelter from the coming storm of government indebtedness. The same driver that is lifting USTs now.