Cambridge Weekly Update – 19th August 2019

Market spat between bond and equity markets

Last week, we suggested that the recent market pullback (down, then up to almost recovered) is unlikely to be the end of this bout of market volatility. Sure enough, markets became even more volatile over this week, despite the Trump administration’s delay to the next round of tariff hikes against China – a move some saw as a desperate attempt to stop the rapid souring of US investor and economic sentiment.

Investors’ aversion to inversion

One of the most closely watched economic indicators finally took a turn for the worse this week. The yield curve – the slope of the graph of government bond yields across increasing maturities – inverted in both the US and UK. In particular, the much watched yield difference between 2-year debt and 10-year debt has turned negative – meaning you now get a higher yield when only tying your capital for two years than you get for a ten year coupon tie. This development is significant and potentially dangerous, but had been entirely expected for a while.

Financials: A sector that might be pricing in too much bad news

Another casualty of the US-China trade war has been the financial sector – which is one of the factors driving down global interest rates. Even with stock markets all over the world taking a hit in the past two weeks, shares of financials have been the biggest losers, with a combination of factors impacting sentiment, particularly in the banking sector. Since November, the KBW index of US bank shares has fallen 5%, whilst the S&P 500 has risen 6%. This pattern is the same globally (see Chart 1) with the UK MSCI financial sector significantly underperforming the MSCI UK equity market.

Read the full commentary here