Listen to the market – China’s inverted yield

The spread between the yield of Chinese Govn’t 2yr and 10yr bonds have inverted. The yield that an investor is receiving buying 2 year maturing debt is higher than the yield from a 10 year bond.

Although the data on the attached graph only starts in 2005, an inverted yield curve signals stress in the credit market and leads to weaker equity markets. It is often a good indicator that precedes recession or a change in economic cycles.

It is notable that United States 2’s/10’s spread inverted in 1978, 1988, 2000 & 2006. Recessions followed within 12-18 months.

The trade to look at, is for a falling Australian Dollar. With this comes a rising US Dollar and falling commodity prices.

An inverted Chinese bond yield could spell trouble for the most crowded of “longs” because not many believe BHP, RIO and the Australian Dollar can fall – for China will apparently keep saving them all.

It is highly likely that China will still buy their products, but there is such a thing as cycles and although China has seemed to have avoided one in the past 15 years, the optimism in this post is to be ready to buy some bargains in Australia, China along with some commodities.

In the meantime, selling AUD and buying USD is hardly the worst trade to consider.

source - Bloomberg

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