Here's what global bond markets tell about US recession, global growth

Hitesh Jain

March was indeed a remarkable month for Global bond markets, with investors widely deliberating on sharp fall in global yields coming amid deceleration in global macros and apparent dovish indications from various central banks.

Uninspiring global macro outlook can be corroborated by lower economic growth projections for various regions. Understandably, Central banks are re-aligning monetary policy stance, quite a divergent scenario when compared with the narrative of policy normalization a year back.

The Fed dictated the sentiment by retreating from the earlier plan of rate hikes for this year, while also tapering the bond portfolio sales to half before ending it by September. In fact, there is growing voice within US political circle to cut interest rates.

This all has exerted downward pressure on the long end of the curve, causing US 10-year/3-month yield curve to invert, a possible sign of impending recession. This comes after the yield curve between 2-year and 1-year and 5-year and 2-year inverted some time back.

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Hitesh Jain

Vice President|Yes Securities

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Flattening curve between widely-regarded 10-year and 2-year also portend ominous indications for the world’s largest economy. Similarly, ECB, BoJ and other major central banks are simply kicking the can down the road on policy normalization.

German Bund yields dipped further into negative territory and were well below the Japanese bonds at one point of time, while British, Italian and French yields have softened as well. The amplified degree of risk aversion can be manifested by investors scrambling for just not low yields, but also negative yielding bonds. To wit, market value of negative yielding bonds in the developed world has surged above US$10 trillion, quite a jump when compared with US$8 trillion at the beginning of 2019.

Although the yield curve does not entirely reflect the prevalent situation in the real economy, it certainly denotes the expectations on the future trajectory of interest rates, inflation and growth.

Lower yields on the longer duration bonds theoretically suggest that the markets are pricing in the possibility of an accommodative policy stance, juxtaposed by descending economic growth rate. To give due credit to prognosis of the bond markets, it is important to note that US yield curve over the several decades has inverted on most of the occasions ahead of a US recession.

Having said that, there can be distortions in the bond markets, where long term rates are artificially suppressed below the short-term bonds. As a case in point, US Federal Reserve’s operation twist in 2011-2012 (read quantitative easing) entailed selling of short-term Treasury bills and buying the long-term instruments. This was done to augment credit creation within the economy by lowering the long-term interest rates.

The other criticism to the yield curve is that it cannot accurately predict when the recession will set in. There have been wide variations in the historical data, which shows that the US10-2yr yield curve has inverted several quarters (ranging from 3 quarters to 2 years) before the economic contraction takes place. So, the moot point remains that if the US10-2yr yield curve inverts now, nobody has the clairvoyance on when the US economy ventures into recession. The so called impending recession can remain elusive for several quarters or even a year or two.

In this respect, Bloomberg Recession probability indicator conveys only 1/4th probability of a US recession in next 12 months. Nevertheless, a flattening yield curve is certainly a veritable indicator of a cyclical slowdown, if not a recession. Various survey and Fed’s own projections call for much slower growth in 2019 and 2020. The recent flow of numbers foretells US on the brink of joining the global slowdown bandwagon. Apparently, tax stimulus buoyancy is fading, with sluggishness seen in US housing and overall consumer spending.

(The author is Vice President at Yes Securities.)

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