Macroscope | Trade war doubts and central bank loosening have done the unthinkable – brought down bond yields and driven up equities

2019 has seen relentless rallies in both bond and equity markets. Bond yields – or interest rates to you and me – fall as bond prices rise, and this usually reflects some combination of falling growth and inflation expectations. In contrast, equities generally like stronger growth. Therefore, bonds and equities usually move in opposite directions.

So how do we explain that US equity indices are at record highs – and global ones not far off – while US 10-year bond government bond yields are back down to around 2 per cent since late 2016? And bond yields in Europe are even lower, with much of the German and French government bond yield at record lows and in negative territory.

For bonds, the major driver of the rally has been the escalation in US-China trade tensions throughout the year which has created economic uncertainty and is already causing growth to slow. The risk is rising that a further escalation of the dispute could exacerbate the already-visible signs of corporate caution and ultimately lead to a slowdown or, if prolonged, a recession.

Markets’ near-term relief on trade may be overwhelmed by economic data showing that global growth momentum is slowing. Trade uncertainty is interacting most obviously in the industrial sector, where sluggish global capital expenditure growth has reduced global goods demand, leaving manufacturers with high levels of inventory.

The data flow has turned noticeably weaker since April, with manufacturing sentiment, in particular, now suggesting little or no growth. And there has been little sign of stabilisation in June’s data, with regions highly sensitive to the industrial cycle such as the Asian manufacturers Korea and South Taiwan actually showing further deterioration.