This research analyses the ability of the yield curve to forewarn a recession. In conclusion, this time IS and IS NOT different:
It’s not the yield curve that predicts recessions, it’s the rise in both short-term and long-term interest rates.
This is because higher rates have increasingly impacted ever more leveraged private sectors.
This time is different because unlike previous recessions, US Households have been significantly deleveraging into this rate hike cycle.
The same cannot be said for the US Corporate sector, which has significantly increased its leverage.
This time is also very different for the US Government – for the first time in recent history there has been a major increase in public sector leverage into the rate hike cycle – US Gov credit growth is less impacted by MonPol.
There has also been an important difference in the source of finance, with a very significant increase in the opaquer private sector credit which can delay reaction to MonPol (through extend & pretend and evergreening).
There are already clear signals that the important US consumer is slowing down - order data suggests the same is starting for the corporate sector.
This time will not be different. HH and Corporate lending data shows that MonPol is working to slow the US economy.
As discussed in a recent piece on the Fed’s thought process, the risk is they hold rates too high for too long.
A look at price sentiment on UST 2s, 5s and 10s shows that a move towards higher yields was firmly rejected and bearish momentum dropped. Crucially, yields peaked below previous highs, opening Head and Shoulders formations and a risk to much lower yields.
Recent research on “Simple Real Yields” demonstrated relative value between global bond markets and which markets are likely to outperform/underperform
The result of the different interest rate performances will surely result in higher cross asset volatility, something not priced into markets.
In summary, some debt trends have been different to previous cycles, leading to different reactions to tighter MonPol, but the impact of higher rates on slowing debt dynamics and the US economy should be no different this time around.
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