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Stock markets tumble, bonds in focus: Is a recession around the corner?

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Are we heading into a recession soon? Let’s break it down: Global stock markets are taking a hit, and investors are worried. They fear a recession could be coming. At the same time, some believe the promises of AI might be overblown. In the bond market, the rush into shorter-dated Treasuries briefly drove yields on two-year notes below those on 10-year bonds for the first time in over two years. Are these fears justified?

For years, people thought the US economy was unstoppable. They believed AI would rapidly change businesses and Japan wouldn’t hike interest rates. But recent events are challenging these beliefs.

HERE’S WHAT HAPPENED

  • Global Markets Plunge: On Monday this week, Japan’s Topix fell 12%, South Korea and Taiwan dropped by 9% and 8%, European markets tumbled, and India’s market plunged over 2%. The S&P 500 ended down 3%.
  • Disappointing Economic Signals: The latest US jobs report showed weak numbers, and major tech companies posted underwhelming AI-driven earnings.
  • Safe Haven Shift: As markets fell, investors turned to bonds, especially in the US, seeking safety.

DOES THIS INDICATE SIGNS OF RECESSION?

The DIU, India Today data team has analysed current and past data with major indicators to determine if the world will face a recession.

Why it matters: The sharp drop in risk assets on Monday this week seems overblown. So does the rush to buy short-term government bonds. In the bond market, investors bought shorter-term Treasuries, causing two-year interest rates to fall below 10-year rates for the first time in over two years. This flip, called a ‘disinversion’, often signals that a recession might be coming.

HOW CAN CERTAIN INDICATORS PREDICT RECESSION?

One such indicator is the long and short interest rate difference (10-year vs. 2-year rates).

A key US Treasury bond market signal, often a recession warning, turned positive for the first time in two years, sparking concerns of an economic downturn.

When the yield curve inverts, comparing two- and 10-year Treasury yields, it usually predicts a recession in one to two years. This inversion has lasted longer than usual. Now the yield curve returned to its typical shape, known as ‘disinversion’ often indicating an imminent recession.

As experts say: An ‘inversion’ is an early warning of a recession, while a ‘disinversion’ signals that a recession may be imminent or already starting.

We used business cycle data from the U.S. National Bureau of Economic Research (NBER) to see past behaviour. Let’s look at a chart that shows the business cycle. Recession periods shaded in gray, while the rest is expansion periods.

Data shows that recessions usually last about 17 months on average. However, the recession caused by the coronavirus pandemic was much shorter—just two months.

We can see this by overlaying a recession plot on a time-series chart of the interest rate difference. The grey areas on the chart showed when recessions happened.

Next, we look at how stock prices, specifically the S&P 500, change during recessions. We overlay a recession plot on a chart of the S&P 500. The grey area shows the recession period. Stock prices usually drop during these times.

A series of earnings reports raised concerns. Big tech stocks, which fuelled the recent rally, seemed overvalued. Profits from A.I. investments hadn’t materialised yet.

TIMING OF RECESSION SIGNALS

A recession often follows a leading indicator’s signal, but the timing varies. This gap can be anywhere from 158 to 996 days. It’s a good idea to notice when the long/short interest rate gap signals a market peak.

Bottomline:

While the yield spread is a helpful tool for predicting economic behaviour, it’s not perfect. Watching the yield spread gives clues about the economic weather, helping us prepare for possible storms.

Published On:

Aug 8, 2024

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