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Macroscope | Is the US heading for a recession? There’s more to it than an inverted yield curve
- Some investors fear the US economy is stalling, which could see the end of the equity market bull run
- However, not only are there doubts about the yield curve’s ability to accurately predict a downturn, other indicators that monitor US recession risk remain healthy
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The US Federal Reserve increased interest rates at its March Federal Open Market Committee meeting, as well as its forecasts for inflation and policy rates. Senior officials have, since then, indicated that the focus will be on tackling inflation.
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The market now expects a 50 basis point rate increase at the Fed’s next meeting in early May. This has heightened market concerns that aggressive policy tightening will not only reduce inflation but also economic growth.
The US Treasury yield curve has flattened significantly. By early April, the two-year bond yield was higher than the 10-year yield, a phenomenon known as an inverted yield curve. Historically, investors have seen this as a warning sign of slowing growth or even recession.
Given the inverted yield curve, some investors are sounding the alarm about the US economy stalling, which could bring the equity market bull run to an end. However, there’s no cause for panic. Not only are there doubts about the ability of the yield curve to accurately predict recessions, an inverted curve does not necessarily point towards an imminent downturn or equities bear market.
Let’s start with whether the yield curve is a reliable indicator of a rising risk of recession. Previously, the shape of the curve was thought to reflect the collective wisdom of bond investors on the economic cycle. When long-term interest rates are lower than short-term rates, it reflects a more pessimistic view of the economy in the long run, implying weaker growth or even a recession.
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During the 2008 global financial crisis, major central banks around the world engaged in quantitative easing by purchasing government bonds and other financial assets. This was done again to address the economic consequences of the Covid-19 pandemic. The aim was to push bond yields lower and reduce the interest burden on businesses and households.
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