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Recession Warning in Bond Market Sharpens, Adding Pressure on Fed

Wall Street has a message for the Federal Reserve: You are not done cutting rates.

Even as the central bank lowered borrowing costs last month, it tried to temper expectations that a string of additional moves were imminent. But in the financial markets, it is clear that investors expect more cuts to come.

In bond markets this week, yields on government debt have touched lows not seen since 2016, when a sharp slowdown in growth — and what many now view as a mini-recession — gripped the economy. The decline implies investors have substantially downgraded their expectations for the economy.

The yield on the 10-year note, which was above 2 percent a little over a week ago, stood at 1.72 percent on Thursday.

Yields move lower when bond prices rise, and the latest leg downward began as the trade war between Washington and Beijing suddenly escalated and investors began to buy government bonds as they sought the relative safety of those investments. The notion that a protracted conflict could weigh on global growth was further fueled on Wednesday when central bankers in Thailand, India and New Zealand — all of which have important trading relationships with China — lowered interest rates more than analysts had expected.

“You see economic fragility across the globe, and central bankers are looking to get ahead of that,” said Dan Ivascyn, group chief investment officer at the bond-focused money manager Pimco in Newport Beach, Calif.

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The economy has fared better in the United States, where unemployment remains near the lowest levels in a half -century.

As a reflection of that strength, officials at the Fed have stopped short of suggesting that they’re at the beginning of an aggressive rate-cutting campaign. Speaking after the July 31 cut, the Fed chair, Jerome H. Powell, said in a news conference that the central bank was viewing the quarter-point cut as a “midcycle adjustment to policy,” rather than the start of a prolonged easing cycle.

And on Tuesday, the president of the Federal Reserve Bank of St. Louis, James Bullard — normally considered one of the policymakers most open to lower rates — also seemed to indicate that he did not see a reason to rush to cut rates in response to every twist of the trade war.

“I think we’ve already adjusted for the ratcheting up of trade policy uncertainty,’‘ Mr. Bullard said. “Let’s wait and see. Let’s see how the economy responds to that.”

Investors do not seem so patient.

In the futures markets, where traders bet on moves in the central bank’s key federal funds rate, another cut in September is seen as a certainty.

The Fed last week lowered the target rate by a quarter point to a range of 2 percent to 2.25 percent. And in the bond market, yields on every security offered by the Treasury Department — from debt that is due in one month to debt due in 30 years — are now below 2.25 percent. That also suggests bond investors expect the Fed’s target range to drop, and stay low for the foreseeable future.

This kind of decline in bond yields below the Fed’s target had happened only twice in the past 20 years, and both times preceded an economic downturn — the bursting of the dot-com bubble in 2001, and as the 2008 financial crisis approached.

The bond market’s most reliable indicator of a recession — the phenomena known as an inversion of the yield curve — has grown even more pronounced with the recent push lower in bond yields. A yield curve inversion occurs when long-term bond yields fall below yields on shorter-term government debt, and one has preceded every recession of the last 60 years.

Key parts of the yield curve for Treasury securities inverted in March, and the recent moves mean those longer-term yields have fallen even further below those of shorter-term debt.

In other words, investors are betting that interest rates are going to be much lower than they are today.

Stephen Grocer contributed reporting.


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