Economic Sentiment and Curve Inversion: The Impact of Hawkish Central Banks and Market Growth Expectations

The resulting curve inversion has accelerated in countries where economic sentiment is weakest. For instance, in the Eurozone the 2s10s swap curve flattened to its most inverted level on record: -78bp. Looking at the same segment of the German sovereign curve for longer history, this seems to be at its most inverted since the early 1990s. So far this year, the lack of interest rate direction, despite elevated day-to-day volatility, has been a supportive factor for risk appetite. The tug-of-war between hawkish central banks and pessimistic market growth expectations has kept rates in a range but it is also bringing about a more inverted curve, a sure sign of worsening economic expectations. This fragile equilibrium continues, for now.

 

Falling rates volatility and inverted yield curves send contradictory signals about the health of the economy

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Today's events and market view

The acceleration in core UK inflation continued in May, to 7.1% annualiased, trumping expectations of cooling price dynamics. Similarly, headline inflation failed to slow, as was widely expected. One day before The Bank of England policy meeting, this ensures odds of a 50bp hike cannot entirely be dismissed.

Bond supply will be skewed to the long-end today, from both ends of the sovereign credit spectrum. Greece will sell 20Y debt, and Germany bonds in the 30Y sector. The US Treasury will also auction 20Y T-bonds.

Central banks will once again be centre stage, with Powell’s congress testimony the highlight. Peter Kasimir, Isabel Schnabel, and Joachim Nagel make up today’s ECB speaker list. The minutes of the Bank of Canada’s ‘deliberations’ will also be closely scrutinised for more details on what drove the central bank to resume its hiking cycle after a five months hiatus.