The bond market predicted a recession. What to watch out for right now.

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The time of dreams


According to the eponymous 1988 film classic, repeating Beetlejuice’s name three times will summon the agent of chaos. Luckily, that doesn’t work for other chaos-makers, given how often the word recession has dominated headlines this week. And there are reasons to believe that we are not yet in imminent danger.

It is understandable that investors are so nervous. The bond market has been showing plenty of warning signs lately, with the Treasury yield curve inverting several times this week after doing so for the first time since 2019 on the last day of March.

This phenomenon, when yields on short-term debt exceed those on longer-term debt of comparable risk – most often two-year and 10-year Treasury bills, respectively – has long been seen as a warning sign. -recession runner. Since higher yields are often associated with higher risk debt, the implication is that the short term is riskier than the long term because the economy is on the verge of collapse.

Add to that the fact that the Dow Jones Transportation Average (DJT) – used by some to take the temperature of the global economy – entered bearish territory on Wednesday, Europe is likely in recession and respected data from the industry are sounding the alarm. No wonder investors are so nervous.

It’s time to batten down the hatches. Or it would be, were it not for the fact that these recession signals are mixed at best.

Take Dow Transportation’s good faith as a leading indicator – yes, it fell into bearish territory in 2020 before the pandemic-induced recession, but it also did so in 2016 and 2018, when no recession occurred. .

Moreover, the debt market itself is not unilaterally pointing to a slowdown. A look at investment grade corporate bond yields shows that investors are demanding a rather paltry premium to Treasuries on them. In other words, investors don’t think the near future looks risky enough to require companies to pay much higher returns for safe-haven assets. Nor are they shying away from risky junk bonds, which are theoretically the first to be dumped in a downturn.

Then there is the reliability of the yield curve itself. In the past, this heralded recessions when the Federal Reserve tightened monetary policy; as money proved more expensive to find, individuals and businesses spent less, leading to a slowdown.

While the Fed is tightening, it is doing so at a very modest pace, and Fed officials have noted that the economic expansion is not on its last legs, thanks to a strong labor market. Some predict that the unemployment rate in the United States could fall below 3% at some point this year for the first time in some seven decades. On Thursday, initial jobless claims fell more than expected, to just 166,000.

It’s good news in the sense that people are taking home a paycheck they can spend, but also in the sense that wages have gone up, providing some protection against the rising cost of essentials like food, fuel and accommodation. Hourly wages increased 5.6% from the prior year period, and while this did not keep pace with inflation, the gap between the two did not have the deterrent effect that many expected.

According to data from BofA Securities, total credit and debit card spending rose an average of 23.3% over three years in March, roughly matching February levels.

Additionally, the company notes that the impact of the sticker shock at the pumps proved relatively small, as spending on clothing – a discretionary category that initially pulled back with gasoline spikes – rebounded after the two first weeks of March among low-income buyers on a three-year basis, a trend also seen in furniture.

Even removing food and fuel – necessities that people must buy regardless of price – low-income consumers have been top spenders on a three-year basis. “The low-income group appears to ignore the gas price shock,” BofA analysts wrote in a report.

Consumers’ wallets aren’t endless, but they have been padded, which may help the bull’s case. By some estimates, consumers have accumulated some $2.5 trillion during the pandemic in excess savings, and while they have recently dipped into those funds, Fed data shows that household financial obligations as a percentage of income are at their lowest for several decades.

That’s not to say investors shouldn’t remain vigilant, and negative developments in the labor market, consumer spending or corporate bonds could be cause for concern. So far, however, so good.

Write to Teresa Rivas at [email protected]

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