Slowdowns in China and US add to sense of panic, leading investors to dump shares and buy bonds

This article is more than 1 year old

This article is more than 1 year old

The prospect of Germany sliding into recession and sharper-than-expected slowdowns in China and the US sent jittery financial markets spiralling downwards across the world to lows last seen in May.

Investors dumped shares and bought safer government bonds, adding to the sense of panic that has grown steadily following Donald Trump’s threat this year of extending tariffs to all Chinese exports to the US.

The inversion of the US yield curve, known as Wall Street’s original fear gauge, for the first time since 2007 was another widely quoted sign that the US economy faced the prospect of a contraction, possibly as early as next year, further fuelling investor fears.

A climbdown by the US president, who has delayed many of the tariffs on laptops and games consoles until after Christmas, failed to prevent the rout after figures for China and Germany revealed that their economies were in severe difficulties.

Q&A What is an inverted yield curve and why does it matter? Show Hide What is the yield curve? This is the line plotted on a graph that shows the rate of return on government bonds to their date of maturity. Government bonds – known as gilts in the UK, treasuries in the US and bunds in Germany – are debt issued over a fixed period of time, typically three months, two years, 10 years and 30 years, to fund government spending. The yield is the rate of return investors receive. Maturity is when the government repays the debt at the end of the term. When more investors are buying government bonds prices go up, and yields drop. Companies can also issue bonds. What happens when the yield curve inverts? This is when the yield on short-term bonds is higher than on long-term bonds. It means that traders are accepting a lower interest rate to hold longer-dated bonds than the shorter-dated alternative. It’s relatively rare – investors typically get higher returns for lending over the long term, as this is seen as riskier than short-term lending. They also expect to be compensated for the impact of inflation, which will eat into investments over time. What does it mean? An inverted yield curve is a classic signal of a looming recession – in the US, the curve has inverted ahead of every recession over the past 50 years. It falsely signalled a recession just once, at the time of the 1998 Russian financial crisis. For other countries the signal is less clear. Several have experienced long periods of inverted yield curves without a subsequent recession, notably the UK in the 1990s. Why is it happening now? The yield curve for two- to 10-year US government bonds has inverted for the first time since 2007, just before the start of the global financial crisis. This indicates that investors are seriously worried about an economic downturn, which would keep inflation low. They are worried about the impact on the already-weak global economy of the prolonged trade war between the US and China, along with Brexit. Is recession inevitable? No, but it is highly likely. And an inverted yield curve driven by recession fears risks becoming a self-fulfilling prophecy, knocking confidence and causing businesses to cut back on investment. How soon does recession tend to follow yield curve inversion? Previous downturns show that yields have typically inverted 18 months, on average, before a recession began. Julia Kollewe





China’s industrial production hit a 17-year low while the growth in retail sales across the world’s second largest economy proved to be lower than expected.

Berlin reported that the German economy, the world’s fourth largest after Japan, contracted by 0.1% in the second quarter of the year, halving the growth rate of the 19-member eurozone currency bloc from 0.4% in the previous quarter to 0.2%.

Fiona Cincotta, senior analyst at the spreadbetting firm City Index, said fears of a global downturn were stalking the markets. “Doom and gloom dominated after data showed that Chinese industrial output grew at the slowest pace in 17 years, whilst the German economy contracted.

“Recession warning bells rang out across the markets as Trump’s delaying of tariffs on some Chinese imports is a case of too little too latte – the damage to economies has already been done,” she said.

Globalisation as we know it will not survive Trump. And that’s a good thing | Larry Elliott Read more

In New York, the Dow Jones index of industrial companies fell 800 points, or 3%, while the index of technology stocks, the Nasdaq exchange, tumbled by 2.9%.

The value of top London-listed shares lost 134 points, or 1.85%, after the FTSE 100 index dropped to 7,116, its lowest in more than two months.

Until recently, investors have focused on the likely impact of US tariffs on growth in the US and China, and stock markets with share values rising and falling with Washington’s running commentary on talks with Beijing.

But the damage caused by the ongoing tariff war on exporting nations in Europe and east Asia has begun to persuade many analysts that the global economy is caught in an unstoppable downshift in growth. In response, investors have rushed to buy highly rated government bonds, including US Treasury bonds and UK gilts.

The stampede meant that the US Treasury 10-year bond yield curve also inverted for the first time since 2007.

The gap between two-year and 10-year bond yields, which translate into the effective interest paid on government debt over different time periods, declined to -0.45 basis points, the narrowest since June 2007.

When short-term Treasury bonds pay a higher interest rate than long-term bonds, it’s generally regarded as a sign that investors believe that an economic calamity is likely and that central banks will be forced to slash rates and keep them low for a decade or more.

Central banks have already responded to the slowdown by cutting interest rates. The US Federal Reserve, which raised interest rates nine times between 2015 and this year as the economy improved, began to reverse its policy in July, cutting back by 0.25 percentage points.

Other central banks have also cut rates, while the European Central Bank, which already applies negative interest rates, said it was likely to loosen monetary policy further in the coming months.

Some analysts said the Fed would be forced to vote on further rate cuts in the next few months to support the US economy.

Steen Jakobsen, chief economist at Saxo Bank, said the speed of the downturn meant the Fed would need to go ahead with rate cuts between meetings. “The Fed is behind the curve and has been since September. The only way to ‘move’ the market now is [cutting rates] between scheduled meetings.”

• Sign up to the daily Business Today email here or follow Guardian Business on Twitter at @BusinessDesk.