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The yield on two-year US Treasuries has fallen to a record low of 0.61pc in a flight to safety, a level not seen during the depths of the Great Depression. Ten-year yields dropped below the psychologically sensitive level of 3pc to 2.96pc.
Such levels are clearly incompatible with assumptions on Wall Street for 3pc growth in the second half of this year. “If the bond market is correct then this recovery could be dead in the water,” said Jim Reid, credit strategist at Deutsche Bank. The credit markets tend to sniff out trouble first and have acted as an early warning alert at every stage of the financial crisis over the past three years.
Mr Reid said deflation has emerged as the dominant risk in the West and will force central banks to renew quantitative easing, the Americans “pre-emptively” and the Europeans “only when their backs are against the world”.
Triple tremors from the banking crisis in Spain, crumbling confidence in the US, and a setback in China’s leading economic indicator all combined with a vengeance on Tuesday. “The market in risky assets has capitulated today amid fears that the global recovery is petering out,” said Gavan Nolan, head of credit at Markit.
Rumbling in the background are influential voices warning of a global slide into economic quagmire.Nobel Laureate Paul Krugman said premature tightening in much of the North Atlantic region at the same time would lead to disaster. “We are now, I fear, in the early stages of a third depression, primarily a failure of policy. Both the United States and Europe are well on their way toward Japan-style deflationary traps. The Fed seems aware of these deflationary risks, but what it proposes to do is, well, nothing,” he wrote.