Employment figures released last weekend in the U.S. that were better than expected caused the yield curve of U.S. government bonds to flip for the second time over the past week.
The Yield Curve reflects the gap between the 10-year yield of the US government bond and the two-year government bond. Many believe that the reversal of the yield curve (a situation in which the two-year yield exceeds ten years) signals A recession is approaching, as most of the recessions that have appeared in the past have preceded such a reversal.In other words, when the long-term return is lower than the short-term it says preachy.
The reversal of the yield curve in terms of the market means that the rising economic cycle (cycle) of interest rates, which only began about two weeks ago in the US, is over, as credit conditions will press the economy, and so the next step in the economic cycle is a recession The S&P 500 closed for the third week in a row of gains, investors are not keeping their feet off the US stock markets for now so why is everyone talking about a recession, or worse, stagnation (inflation combined with a recession).
“The recession is still far away, probably not before 2024 and maybe only in 2025,” say leaders of capital market leaders. “Over the course of the year, the next two years the US economy will benefit from a number of growth locomotives. The tight labor market is leading to wage increases especially at low wage levels. Expansion in private consumption is expected to continue, albeit at a relatively moderate pace due to inflationary erosion; Production after a sharp decline in inventories; investments are in a positive swing both against the background of the desire to encourage the development of green energy and to bring back important industries from Asia to the US; The traditional energy sector has started to increase investment against the background of the jump in prices and also with the aim of reducing dependence on Russia. This means that the possibility of entering a recession exists but is still far away. Therefore, the Fed is expected to continue to tighten monetary policy in the next two years, which is expected to lead to a continued increase in yields to 10 years towards 3% by the end of the year, “Lider economists wrote in their weekly review.
“The best indicator of a recession”
Uri Greenfeld, Psagot’s chief strategist, mentions that the Fed published a work less than two weeks ago entitled: ‘Do not be afraid of the yield curve (continued)’, which came to explain to investors that the yield curve reversal is not necessarily a sign of recession but may be due to other reasons. “Of course, history shows us that this is no less silly when not only in the last 70 years whenever the curve has been overturned there has been a recession (except in the mid-1990s when huge investments in internet infrastructure managed to prevent a recession) but also whenever the curve is reversed someone Fed says there is nothing to panic about (Bernanke’s “This time it’s different” speech in 2006, for example) and eats a hat after that.
“The truth is that what’s really amazing is that the same writers who published the study last week, published the original article in 2018 and even then they were probably wrong. True, the recession came in the wake of the corona but the Fed started lowering interest rates even before the corona, “The American would probably have entered a recession in 2021. Therefore, the bottom line is that it is difficult to argue with market behavior that has been consistent for so long,” Greenfeld wrote.
“The rollover curve is the best indicator of an impending recession and although it is problematic in terms of timing (24-12 months ahead of the recession), it is excellent in terms of end result. So what do you do when the curve is reversed, run away from the market before the recession arrives? “In our view, because much of the current inflation is due to supply factors and is expected to fade towards the end of the year and because the deflationary structural factors (mainly demographics) that characterized the last 20 years have not yet disappeared, the answer is no,” Greenfeld wrote.
High inflation increases the attractiveness of real assets
Amir Kahanovich, chief economist at Phoenix Excellence, wrote in his weekly review that “one of the common explanations for the strength of the stock market is high inflation, which increases the attractiveness of real estate, but another argument is that the next recession will be a technical recession, a kind of hangover.” “The demand is after the corona and not necessarily an explosion. Goldman economists, for example, claim that this will not be a type of financial imbalance that has been violated, but rather a fading of incentives.
“Continued rises in the stock market do not necessarily support arguments that the next recession will be easy, since in the past stocks continued to rise after reversals of the yield curve, and sometimes even continued to rise for several more years. “It is important to remember that the reversal of the yield curve is not the recession itself but an indication and not the cause of the recession, but the tight economic conditions that increase the sensitivity of economies to enter a recession,” according to Kahanovich.
In Israel, the market embodies interest rate hikes at a more moderate pace
The reversal of the yield curve is mainly due to the strengthening of estimates for interest rate hikes in the US at a faster rate of half a percent in the coming Fed meetings. In contrast to the American curve, which is partially inverted, the Israeli yield curve has a positive slope along its entire length.
Bank Hapoalim economists write in their weekly review that “some economists see the reversal of the American curve as a precursor to a sharp slowdown that will require a change in the Fed’s monetary policy. The term is low today compared to the past, so even if the Fed responds to the high inflation data in the coming year, it is a process that does not represent the real long-term interest rates required. “.