LDN - Business

Bond bulls get a boost as trade tensions fan recession fears

[May 29, 2019] By Sujata Rao

LONDON (Reuters) - The global bond rally accelerated on Wednesday, sending 10-year U.S Treasury yields to 20-month lows, as investors fearful of the fallout from the Sino-U.S. trade war sold shares and scurried for the safety of German and U.S. government debt.

U.S. 10-year yields are down almost 30 basis points this month, while German yields slipped deeper into negative territory to the lowest in almost three years.

Wall Street was set to open lower, with S&P500 futures down 0.7%, still feeling the effect of U.S. President Donald Trump's comment that he was "not yet ready" to make a deal with China over trade.

Chinese newspapers responded on Wednesday with a warning Beijing could use rare earths to strike back at the United States. China is a major producer of rare earths, which are used widely in electronics and military equipment.

The prospect of a prolonged standoff between the world's two biggest economies and the likelihood of Europe and Japan getting dragged in, are making investors seriously worried about economic growth.

Recent data, such as purchasing-manager surveys, have disappointed and another round of tariffs would sharply raise U.S. recession risk, said Justin Onuekwusi, a fund manager at Legal & General Investment Management.

"The market is simply calculating what the impact will be of the next set of tariffs as it doesn't look like the rhetoric is calming down," Onuekwusi said.

"Then we have a weaker growth outlook ... so we have the negative shock of trade added to lower growth, and the cushion of protection isn't as good as it was eight to nine months ago."

Those concerns pushed MSCI's global equity index 0.5% lower to 2-1/2-month lows <.MIWD00000PUS and put it on track for its first lossmaking month of 2019.

Asian markets too fell while in Europe, Germany's exporter-heavy index slumped 1.4% and a pan-European benchmark lost 1.3%.

U.S. bond and equity volatility is also on the rise.

(GRAPHIC: Bond and equity vol on the rise - https://tmsnrt.rs/2IiffRh)

On the political front too, many fear eurosceptic parties' strong showing in EU elections could allow them to hamper crucial legislation; Austria and Greece face elections; and Italy's dispute with the European Commission over its budget may be escalating.

BOND RALLY ACCELERATES

All these concerns have given fresh legs to the rally in government bonds, which will also benefit from interest rate cuts if the growth outlook worsens.

U.S. 10-year yields are now about 13 basis points below 3-month rates, an inversion typically seen as a leading indicator of a recession.

(GRAPHIC: U.S. Yield Curve - http://tmsnrt.rs/2zUqXiW)

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A passerby walks past in front of a stock quotation board outside a brokerage in Tokyo, Japan, May 10, 2019. REUTERS/Issei Kato

The inversion is the deepest in almost 12 years, exacerbated by recent weak U.S. data on manufacturing and industrial output.

U.S. rates futures are pricing two interest rate cuts by mid-2020.

"Typically when the yield curve inverts you get central bank easings. So the question about recession would be: would the U.S. Fed ease enough to avoid a recession?" said Chris Rands, portfolio manager at Nikko Asset Management.

"The fact that you have got a bit more noise around the trade war now at the same time as manufacturing is rolling over -- it's getting people to think that things are a little bit worse than they had expected," he said.

The gap between two and 10-year German Bund yields was the narrowest in almost three years. Ten-year Bunds now yield minus 0.17% and are down 10 bps since the start of May.

Bunds are benefiting also from tensions between Italy and the EU, which is said to be considering punishing Rome for excessive spending.

Regardless of Italian risks, the rally spread to the riskier southern European countries, where Spanish and Portuguese 10-year yields hit record lows and Italian yields fell five bps.

Onuekwusi said he preferred Italian and Spanish bonds over their negative-yielding German counterparts. The EU is unlikely to impose too severe a punishment on Italy, he argued.

"If you look at Europe's political landscape, the last thing the (EU authorities) would want to do is to stir up any more negative EU sentiment," he said.

(GRAPHIC: Investors pile into Southern European debt - https://tmsnrt.rs/2WaH7QR)

On currencies, the dollar index was set for a fourth straight month of gains, benefiting from flows away from markets such as Asia that are considered at greater risk from a trade war.

The euro was unchanged at $.1.117 after falling two straight days. The British pound held at $1.2643.

Commodity markets were also dominated by fears of economic downturn, with Brent crude off almost 2% at $68.79 per barrel. But gold benefited from the safe-haven bid, rising 0.3% to $1.282 an ounce .

(Additional reporting by Swati Pandey in Sydney; Editing by Alison Williams)

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