Economy

This Market Indicator That Frequently Signals a Recession Just Flashed Red

This Market Indicator That Frequently Signals a Recession Just Flashed Red”

The dollar, which started the week on a weak footing as the apparent thaw in trade tensions between the USA and China cooled demand for the safe-haven currency, extended its fall as investors anxious about the inversion of the short end of the US yield curve in bond markets.

Concerns about slowing USA growth have accelerated the flattening of the yield curve, a phenomenon in which longer-dated debt yields fall faster than their shorter-dated counterparts.

Simply, the yield curve tends to invert before economic downturns.

On Monday, stock markets around the world got some relief after Washington and Beijing agreed to temporarily end their trade war during talks at the G20 summit in Argentina.

In an "economic letter" published by the San Francisco office of the U.S. Federal Reserve (Fed), Michael D. Bauer and Thomas M. Mertens summarize the implications of an inversion succinctly: "Every U.S. recession in the past 60 years was preceded by a negative term spread, that is, an inverted yield curve". When short-term yields move higher it can imply doubts about the immediate future.

Dallas Federal Reserve bank president Robert Kaplan said the Fed was now in a "more challenging" period as global growth slows and parts of the American economy begin feeling the impact of Fed interest rate increases. Powell in remarks last week reiterated his upbeat outlook of an economy growing above potential, with the unemployment rate the lowest in almost 50 years, and in no need of emergency level interest rates. In its view, those rate hikes are putting the brakes on borrowing and hiring, keeping inflation under control. It has spread to the eurozone, where the German 2-10 yield curve is at its flattest since mid-2017 at 85.70 basis points.

On Tuesday, three-year Treasury yields fell below two-year notes for a brief moment before bouncing back. This may, in turn, lead to lay-offs and a slowdown in employment and growth and ultimately force the Fed to cut rates to spur the economy.

"The curve has to invert and it's going to happen sooner than people think".

No - and that's why this latest flip in yields may not augur recession.

However, investors are increasingly concerned by a flattening of the spread between 2-and 10-year Treasuries, a more fundamental benchmark of market health. A rate hike however, while signaling confidence by the Fed, would continue to make financing more expensive for firms and households. But most economists say the chances of a near-term recession are slim, pointing to strong hiring and consumer spending, among other positive trends.

Global stocks tumbled on Tuesday as a flattening Treasury yield curve sparked recession warnings, while optimism sharply waned that the United States and China would quickly resolve their trade dispute.

"Current rates of consumption, investment and employment growth in the major developed markets are not historically consistent with an impending recession", UBS analysts wrote in a research note this week. Asked about the possibility of an inversion at a June press conference, Powell said "what we really care about is what's the appropriate stance of policy".



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