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Yield Curve’s Dark Vision for Growth Is Backed by Factories Slump

Yield Curve’s Dark Vision for Growth Is Backed by Factories Slump

(Bloomberg) -- The evidence to support what the Treasury yield curve has been saying about the likelihood of a recession is starting to stack up.

U.S. traders back from their final summer holidays got a jarring welcome Tuesday, as data showing an unexpected slump in U.S. factory output sent yields sliding again. The moves entrenched the inversion in parts of the curve that have proven reliable harbingers of recession.

The 10-year yield dropped as much as 8 basis points to 1.43% on the release of the Institute for Supply Management‘s survey. That drove it close to the lowest it’s been versus the three-month rate since this spread inverted in March for the first time this cycle.

Yield Curve’s Dark Vision for Growth Is Backed by Factories Slump

“That’s the rates market basically forcing the Fed to act, which they’ve been reluctant to do,” said Stephen Bartolini, fixed-income portfolio manager at T. Rowe Price in Baltimore.

The central bank cut rates by a quarter-point cut in July, and is widely expected to deliver another in September. But the market is homing in on policy makers’ conservative approach to easing as the trade war takes its toll. After Tuesday’s data, traders added to positioning for rate reductions this year, and now expect at least half a point of additional cuts.

That said, it’s hard to push those odds much higher while the American consumer continues to support the economy, and the services sector -- which contributes the lion’s share of U.S. growth -- remains resilient. The next survey on the services sector is due Thursday, and is forecast to reflect continued expansion.

Bartolini said he expects the curve to push deeper into negative territory until the Fed signals more dramatic action to counter risks to the economy. The other condition is that “trade doesn’t improve -- which I think is a pretty good assumption.”

He sees yields pushing lower still, and favors five- to seven-year Treasuries. He’s not taking chances with a curve position, which could get upended if the Fed offers stronger assurance of more easing to come in its Sept. 18 decision.

To contact the reporter on this story: Emily Barrett in New York at ebarrett25@bloomberg.net

To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, Mark Tannenbaum, Rita Nazareth

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