Downturn concerns resurface

The warm fall weather persists into October, yet the financial cold front from September is more concerning. Our upcoming article delves into the recent asset class performances.

Currently, financial markets are experiencing a disconnect between global economic indicators and certain asset price movements. This week, mirroring last week’s trend, global long bond yields rose, even with global economic soft spots. The 10-year US Treasury yield reached 4.88% on Tuesday, a 15-year peak. Other bonds reacted similarly, albeit less intensely. Due to the inverse bond yield-price relationship, government bond prices dropped. After a robust US job report, yields are climbing again, now 0.15%-0.30% above last week, leading to a 1.5% drop in the global bond index.

As of now, global stock markets have generally declined by about 2.5% in GBP terms, largely attributed to the effect of rising bond yields rather than economic growth concerns.

Conversely, commodities, especially oil, have faced a downturn, seemingly due to reduced growth expectations. Brent Crude dropped 13.5% in three days, returning to its late August price of $85 per barrel. Industrial metals also saw a 4% decline. Commodity investors appear more pessimistic about global growth.

Frequent readers might recall our stance on bonds as economic health indicators. Typically, bond yields mirror economic activity levels. A chart below illustrates the US 10-year Treasury yield and US nominal growth since 1990, using Oxford Economics data:

US YieldsLike many, Oxford Economics predicted a 2023 US economic slowdown but was taken aback by its robustness. Predictions of a 2023 slowdown were off-mark, both in the US and the UK. While goods trade has decelerated, service demand remains strong. Service-centric economies like the US and UK have outperformed expectations, while goods-centric ones like China and Germany have lagged. The job market remains buoyant, maintaining consumer confidence.

However, a slowdown is anticipated as fiscal stimulus diminishes next year. Rising yields could exacerbate this. The question arises: why the surge in bond yields? Some investors might have been overly optimistic about an impending slowdown, influenced by economic sentiment metrics like PMIs. Some locked in seemingly favourable yields, while others faced significant losses due to incorrect bets. This price movement reflects past miscalculations rather than altered market expectations.

Some investors traded equities for long-term bonds, anticipating an economic deceleration affecting stock markets. While rising bond yields impacted stock prices, earnings projections remained stable. The upcoming Q3 earnings season might bring clarity, especially regarding 2024 forecasts.

Market fluctuations have intensified across assets, indicating tightening global market liquidity. This, combined with central bank actions and losses in bond and commodity markets, suggests a potential economic slowdown. Elevated bond yields might eventually decrease.

For stock and credit markets, bond yields might stabilize and then drop with minimal impact. However, liquidity tightening signals potential volatility risks. Bond yields might decrease further if risk assets face pressure, potentially due to economic frailty affecting earnings projections, making a significant equity rally challenging.

Upcoming central bank rate meetings could exacerbate issues if perceived as aggressive. Yet, upcoming inflation data might be more benign, possibly leading to a more cautious stance in the coming days. We remain hopeful.

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This article is for information purposes only – should not be perceived as financial advice. We recommend you should always speak to a financial adviser before making any investment decisions.

Please note, past performance is not a reliable indicator to future returns. Your investment may fall as well as rise, and you may not get back what you put in.