Four data points to consider today, all focused on capital markets prices but each addressing different issues.
#1: US Corporate Debt Credit Spreads. With US corporate debt outstanding at record highs relative to GDP and plenty of uncertainty about 2020’s economic environment, you’d think marginal credits would be seeing their spreads to Treasuries increase.
In fact, the opposite is the case. Single B US corporate credit spreads are currently 393 basis points over Treasuries today. That is the second lowest daily reading over the past year. CCC credits are hurting, to be sure, with a 1,090 spread and close to 1-year highs. But at the better end of the junk spectrum, BB spreads are at fresh 1-year lows today (208 bp).
Bottom line: junk bonds are mirroring the US equity market’s optimism about 2020 in all but the worst credits.
Here is a 1-year chart of the single B spread for reference:
#2: Chinese Offshore Yuan. This more-freely traded version of the Chinese currency has weakened by 12% since Q1 2018, essentially the start of the US-China trade war. This has offset half or more of the 15-25% tariffs imposed by the US.
It was not until August 4th 2019 that the yuan broke the 7.0/$ level that was long considered to be the “line in the sand”. Since then it has closely tracked capital markets’ net assessment of progress towards a trade resolution:
- Its worst level of 7.16/$ occurred on August 25th, very close to the lows in global yields and the S&P’s 2H 2019 lows.
- Recent levels for the offshore yuan point to some – but not complete – confidence that trade talks are heading in the right direction.
- The current rate of $7.03 is still over the 7/$ level, but at least stable there.
Bottom line: the offshore yuan is not discounting any rollback of US tariffs (bad news), but at least it believes there will be no incremental increase on December 15th, the next deadline (good news).
Here is the 1-year chart for the offshore yuan/dollar cross:
#3: German Bund Yields. Fun fact: in December 2011 the yields on 10-year Treasuries and German bunds were exactly the same at 1.8%. Fast-forward to today and Treasuries still yield 1.8% but bunds trade for a negative 0.3% yield. No prizes for which country has a larger budget deficit (hint: Germany has none) or which central bank has been buying long dated bonds longer. Or which region (US vs. Europe) is at greater risk of recession from the ongoing US-China trade war, for that matter.
Bottom line: as much as the dollar is the world’s reserve currency, the 10-year German bund is the globe’s ultimate safety asset, so the direction of bund yields basically measures investors’ risk appetites in real time. By this metric markets are wavering about what 2020 may bring. Yes, bund yields are off their late August lows of -0.71%. But, at 0.32 today they have not moved substantially since early November.
Here is the 1-year chart of 10-year German bund yields (source: CNBC):
#4: 10-year minus 3-month Treasury yields (AKA “recession indicator”). At the height of the late-summer global negative yield scare, 10-years yielded 50 basis points less than 3-month bills. That drove the NY Fed’s Recession Probabilities model to +30%, a level that has reliably predicted both recession and 12-month forward S&P declines back to 1990.
More recent moves in the US Treasury yield curve point to a more sanguine picture. The current spread is positive to the tune of 29 basis points. On a more cautious note, it hasn’t really moved in over a month.
Bottom line: the latest NY Fed Recession Probability reading is 24%, which is still troublingly high. To be safely out of danger, the difference between 3-month and 10-years needs to be over 50 basis points.
Here is the chart of 10-year minus 3-month Treasury yields:
Summing up: taken as a whole these 4 indicators are generally more cautious on the macro outlook than US stocks. Junk credit trades well, which is the one exception. The offshore yuan says there is no imminent trade breakthrough coming, however. German bund yields are out of the cellar but have no momentum. And recession probabilities remain stubbornly high. There is still a wall of worry out there; it’s just least visible in US large cap equities.