The American economy has such a special tradition since the Korean War. Every future economic recession was first preceded by an inverted yield curve on US bonds. A similar situation is happening now. Worry time?
Let’s first summarize how this mechanism normally works. Under normal circumstances, the bond yield curve should steepen over time in order to induce investors to leave their funds for a longer period and therefore take on higher risk. Bonds with longer maturities should therefore offer higher yields than bonds with shorter maturities.
When the yield curve turns, it usually means that investors are beginning to question the continuation of economic growth. Here too it is certainly true that nothing is usually eaten as hot as served – in our case it should be borne in mind that this is more of a correlation than a causation.
In other words, every recession was preceded by a reversal, but not all reversals were followed by a recession. So, does the yield curve matter to us?
“The current economic situation is one of the worst we can remember,” says Dominik Stroukal, chief economist at the Roger Payment Institution.
“Closed economies and war all cause recession, and it’s no wonder we’re looking for any indication that there might be a deep downturn. However, economies will fail in real terms, even if it isn’t called not a recession,” he said.
“With high inflation and low growth, the economy will not grow at constant prices this year and it will be a deep real decline. However, if the product did not grow in nominal terms even with high inflation, it would be a real warning that we are rushing into the abyss,” Stroukal continues.
According to him, however, there is no need to worry too much. “It’s not a 100% indicator, and there may be more than one point of view on income differences. Also, the current situation is really particular. So – each situation is specific, but honestly, a pandemic and a war at the same time, it can already deal with economic indicators”, he recalls.
“It was also a short, slight drop in the yield curve. Will the recession come? Concretely, we are already there. Will it come as we have known it since 2008? Probably sometimes. Will it be this This year would require more signals than a slight inversion of the yield curve,” he concludes.
How should an investor handle this? “I wouldn’t worry too much about the shape of the yield curve yet. The yields on two-year, ten-year, and 30-year U.S. government bonds are about the same, so the curve has a shape flat less usual, but it does not matter much for equity investors,” says Daniel Gladiš, founder of the Vltava Fund.
He gives two reasons. “First of all, bond markets are badly distorted by central bank buying, and the question is whether bond prices are therefore informative enough. I think they have it much smaller than before. in the past,” he explains.
“Secondly, even if the curve was signaling an impending recession, and it is, that doesn’t say much about where the stock is going. These can go up and down during a recession, so I think that investors should pay utmost attention to studying the companies they own or intend to buy, so that they have a clear idea of the price that is reasonable for them,” Gladiš urges.
Economist Michal Skořepa from Česká spořitelna also agrees that the current market situation is very far from the natural state.
“With the onset of quantitative easing, central banks began to directly influence the position of the yield curve not only in the short term, but also in the longer term. In the economy, longer-term earnings therefore also reflect current central bank action in the area of buying or selling longer-term assets,” he explains.
“So if we are interested in the view of the market, the shape of the yield curve is no longer such a clear source of information. For example, the inverted yield curve may mean nothing more than that the central bank has decided to tighten monetary policy more strongly than how, if at all, it is quantitative tightening,” he gives an example.
According to Jan Berka, editor of financial portal Roklen24 and chief forex analyst at Roklen, most of the US yield curve has gradually inverted in recent weeks.
“The Fed has fallen asleep. High inflation and the threat to the anchoring of long-term inflation expectations will lead to the fastest and most intensive interest rate cycle on record,” says Berka, the evolution current market situation, and that the cycle will also be one of the shortest.
“We see the first predictions of a rate cut at the turn of 2023 and 2024. The bond market is one of the smartest. This shows us how bond traders assess the economic outlook and the subsequent outlook for the economy. American,” he said.
“The Fed began raising interest rates during the so-called bearish yield curve flattening. This is characterized by rising rates on medium-maturity instruments before longer rates, that is, “That is to say from ten years. And it is the pace of rate increases reflected on average maturities that is the main variable in the debates on a possible recession”, specifies Berka.
According to him, the Fed will not avoid a monetary policy compromise, as it essentially “exchanges” part of the economic growth for lower inflation. The question will be its strength.
“It can be a slowdown in growth, but also a recession, to which longer-term supply problems could contribute. However, the inverse yield curve does not tell us that,” explains Berka So we can only read off the curve in which direction bond traders believe US monetary policy should go.
“It would be premature to judge in the current situation that the US economy will fall out of recession in less than two years. The worst that could happen would be self-fulfilling doomsday scenarios. The Fed has a difficult task ahead of it, as the current economic environment, with its emphasis on high inflation and the tightest labor market in history, reduces the likelihood of a so-called soft landing,” concludes Berka.
“If we stick to historical data, stocks and bonds have risen since the second half of the 1970s, between the inversion of the yield curve and the recession, if any. For example, the S&P 500 index gained more than five percent on average,” he concludes.