OPINION
Market Rating Before FOMC MeetingJan 31
US Yield Curves: Recession can't be avoided
In recent asset prices in global markets, recession concerns for developed country economies have risen significantly.
With the uncertainty of the coronavirus cases in China under the shadow of the Russia – Ukraine war and the tightening cycle of developed countries' central banks, concerns that economies may fall into recession are likely to be the case in the markets.
At this point, the US Federal Reserve, which is in a leading position on monetary policy, undoubtedly plays a major role. In March, the Fed started the tightening and accelerated it in May and June. In June meeting, the Fed raised its federal funds target to the range of 1.50 – 1.75 percent with a tightening of 75 basis points, the largest scale in 28 years, above the forecasts of a 50 basis point. It is almost certain that the Fed will go for another 75 basis point rate hike at its critical July meeting.
As a matter of fact, the world's largest economy is also signaling a slowdown. S&P Global Inc., a Manhattan-based financial information provider, noted on Friday that the manufacturing purchasing managers’ index (PMI) maintained its strong course despite the loss of momentum with 52.3 points, while Services PMI contracted for the first time since July 2020 and registered as 47.0 points.
The PMI data, which is a preliminary indicator of economic performance, is a sign that gross domestic product (GDP) may also shrink in Q2. This is, a contraction for two consecutive quarters, defined as a recession. However, domestic demand in the United States remains the main driver of growth by staying strong. As the US Department of Labor reported, the personal consumption expenditures price index (PCE Deflator) increased by 0.6 percent in May compared to the previous month and was 6.3 percent year-over-year. - the US economy shrank by 1.6 percent according to the final data in Q1.
However, the global bond market prices are moving in line with the possibility of the US economy entering a recession. While the 10-year US treasury yields are trading around 2.79 percent, the 2-year US treasuries are above 3.00 percent. The 2-year yield curve, which regressed as the 2-year interest rate shifted strongly above 10-years, seems to have found equilibrium around minus 0.22 region after the lowest level of 22 years it saw, which was minus 0.238 percent. However, we observe a recovery from the 0 percent level to 0.14 percent level in 5- to 30-year yield curve.
In other words, the yield curves reveal the pricing of short-term forecasts that the US economy will fall into a recession. As a matter of fact, this is the most important reason for the pressure on the US stock markets and developed country currencies. On the other hand, the long-term yield curve also indicates that growth will continue on a relatively favorable track.
Considering all these, the Federal Reserve's July meeting is extremely critical. If the Fed can sufficiently convince the markets of its willingness to control inflation without strangling the economy, it can also move the short-term yield curve back into positive zone and relieve the US dollar's pressure on the asset prices.
With the uncertainty of the coronavirus cases in China under the shadow of the Russia – Ukraine war and the tightening cycle of developed countries' central banks, concerns that economies may fall into recession are likely to be the case in the markets.
At this point, the US Federal Reserve, which is in a leading position on monetary policy, undoubtedly plays a major role. In March, the Fed started the tightening and accelerated it in May and June. In June meeting, the Fed raised its federal funds target to the range of 1.50 – 1.75 percent with a tightening of 75 basis points, the largest scale in 28 years, above the forecasts of a 50 basis point. It is almost certain that the Fed will go for another 75 basis point rate hike at its critical July meeting.
As a matter of fact, the world's largest economy is also signaling a slowdown. S&P Global Inc., a Manhattan-based financial information provider, noted on Friday that the manufacturing purchasing managers’ index (PMI) maintained its strong course despite the loss of momentum with 52.3 points, while Services PMI contracted for the first time since July 2020 and registered as 47.0 points.
The PMI data, which is a preliminary indicator of economic performance, is a sign that gross domestic product (GDP) may also shrink in Q2. This is, a contraction for two consecutive quarters, defined as a recession. However, domestic demand in the United States remains the main driver of growth by staying strong. As the US Department of Labor reported, the personal consumption expenditures price index (PCE Deflator) increased by 0.6 percent in May compared to the previous month and was 6.3 percent year-over-year. - the US economy shrank by 1.6 percent according to the final data in Q1.
However, the global bond market prices are moving in line with the possibility of the US economy entering a recession. While the 10-year US treasury yields are trading around 2.79 percent, the 2-year US treasuries are above 3.00 percent. The 2-year yield curve, which regressed as the 2-year interest rate shifted strongly above 10-years, seems to have found equilibrium around minus 0.22 region after the lowest level of 22 years it saw, which was minus 0.238 percent. However, we observe a recovery from the 0 percent level to 0.14 percent level in 5- to 30-year yield curve.
In other words, the yield curves reveal the pricing of short-term forecasts that the US economy will fall into a recession. As a matter of fact, this is the most important reason for the pressure on the US stock markets and developed country currencies. On the other hand, the long-term yield curve also indicates that growth will continue on a relatively favorable track.
Considering all these, the Federal Reserve's July meeting is extremely critical. If the Fed can sufficiently convince the markets of its willingness to control inflation without strangling the economy, it can also move the short-term yield curve back into positive zone and relieve the US dollar's pressure on the asset prices.
