That was not the only occasion that an inversion in this part of the US bond curve accurately predicted a recession.

“Historically, the yield curve has been a reliable indicator of recession,” said Kerry Craig, Global Market Strategist, JP Morgan Asset Management.

” Seven of the last nine times the spread between the US 10-year and 2-year became negative a recession followed. It wasn’t immediate and took on average 14 months for the recession to begin after the yield curve inverted.”

Given its predictive powers, it came as no surprise that within seconds of the inversion occuring there was a flurry of headlines about a looming US recession, contributing to selloff in riskier asset classes. Suddenly, it wasn’t just those who work or follow financial markets that knew of the power of the yield curve to predict recessions, but many.

Given the prominence it has received, does that increase the risk of changing investor, business and consumer behaviour, creating the potential for a “doom loop” that could actually bring on a recession?

While the future is not certain, and trying to predict the actions of a collective group are fraught with danger, strategists believe the coverage the yield curve inversion has received has increased the risk of a global economic downturn.

“It definitely does,” said Damien McColough, Head of rates strategy at Westpac Bank.

“While yield curve inversions have been good predictors of recessions in the past, they have not been perfect.

“However, the widespread coverage of the current inversion in the media is sure to have an impact on behaviour which can definitely be self-fulfilling, especially when it comes to influence the more commonly followed market indicators such as equities.”

Mr McColough said the decline in longer-dated government bond yields, resulting in the latest inversion of the US bond curve, reflects not only that investors are revising down their expectations for global growth but also the ability of central banks to stimulate economic activity.

“Global growth prospects are being revised lower, and hence expectations for real returns along with the associated inflation expectations,” he said.

“At such low yields – with high levels of household, government and business indebtedness – it is more difficult for monetary policy to transmit into the real economy in the same way it did in the past.”

Rodrigo Catril, senior FX strategist at the National Australia Bank, agrees that the focus on the yield curve could exacerbate concerns about the economic outlook.

“The negativity has become part …read more

Source:: Daily Times

      

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The ‘doom loop’ that could bring on a global recession

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