Recession fears are sweeping global markets after key data from the US signalled we could all be heading for a slow down.
By the late morning on Thursday, the ASX200 index – Australia’s biggest 200 listed companies – had plunged by more than 2% following a horror session on Wall Street overnight, and stock markets across Asia and Europe fared little better.
US stocks took a beating Wednesday when it was revealed that the US treasury yield curve for 2 and 10 year bonds had inverted for the first time since 2007.
Why is this event causing so much commotion? Because the inverted yield curve is considered to be one of the main forecasters of a recession. Since the 1950’s, every recession (of which there has been 9) has been fortold by an inverted yield curve, according to data from the Federal Reserve.
Because the United States claims more than half of the value of shares globally, US bond yields are closely watched by analysts the world over. Basically, if the US falls into recession, the world is almost certain to follow.
It’s not the first time this year a yield curve has inverted. In March, the 3-month to 10-year US treasury yield curve also inverted for the first time in over a decade, sending alarm bells around the globe. Now the same has occurred with the 2 to 10-year yield curve.
The graph below shows every year the 10 and 2 year US treasury bond yield curve has inverted, while the shaded parts indicate a recession.
Spread between 10-year and 2-year US treasury bonds
Source: Federal Reserve Bank of St. Louis
What is an inverted bond yield curve?
When you invest in the bond market, you’re loaning money to the government or a company for a set period of time – several months or many years. In return, you receive interest payments and the principal paid back at the end of the bond’s term.
In a normal healthy economy, interest or yield on a short term investment will be lower than what is offered for a longer term investment.
But when the yield curve inverts, the opposite is true. Short-term bonds, such as three-month or 2-years bonds have higher yields than longer-term 10-year bonds.
This indicates that the market is expecting a major slow down to occur. Essentially, investors believe long-term bonds of 10 or 30 years will be a safer bet for their money than short-term, even if they expect lower …read more
Source:: Daily Times