Multi-Asset

Recession?

Is a recession on the cards? We examine some of the warning signals.
April 2019

Risk Disclaimer

The value of investments and any income derived from them can go down as well as up and investors may not get back the original amount invested.

Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.

The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.

Most recessions creep stealthily upon you. Often you have found that it commenced some months ago whilst you and others were still eulogising over the strength of the economy. There is no sure-fire way of knowing when a recession will strike – just ask the IMF how difficult it is – but one measure that does provide a fairly good indicator of looming trouble is the gap between short and long-term interest rates.

The theory runs that long-term rates should be higher than short-term rates because of the greater risk involved for the investor. No argument there. So what is going on when the curve inverts? That is, when short rates exceed long rates. It suggests that investors are piling in at the long end of the curve (pushing yields down and prices up) because of an expectation of lower economic growth and an overall softening in interest rates. And that, in a nutshell, is what is happening now.

The chart below examines the “gap” between 3-month Treasuries in the US and 10-year bond yields since 1990. The gap turned negative in July 2000 (the recession started in March 2001), negative in August 2006 (recession commenced at the end of 2007) and is now sitting precisely at zero. As recently as last November the 10-year yield was over 3%. If past form is any guide, it suggests that 2020 could be a pretty dodgy year.

Risk Disclaimer

The value of investments and any income derived from them can go down as well as up and investors may not get back the original amount invested.

Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.

The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.

US: Yield spread

Difference between 10-year Bonds and 3-month Treasuries

Source: Thomson Reuters Datastream

Use our handy glossary to look up any technical jargon you are unfamiliar with.

It is also pertinent that the US Federal Reserve (Fed) has publicly abandoned any suggestion of an official interest rate increase in 2019 – a total about-face from its stated position at the end of 2018. It is also likely to cease quantitative tightening – the non-replacement of bonds on its balance sheet as they mature. This remains a far cry from quantitative easing but nevertheless represents a significant change in demeanour.

The Fed has also reaffirmed its view that trend US real GDP growth will be in the range of 1.75%-1.8%. This is marginally more pessimistic than our trend forecast of 2%. Either way, it leaves the US stock market at a precariously high value relative to potential growth. The Dow Jones index first hit 26,000 in January 2018 and is below that level today. It has therefore spent more than a year going nowhere. Perhaps we are witnessing another portent of dodgy times ahead.

Yields on 10-year bonds have fallen in all major developed economies over the past six months. It is remarkable how swiftly the investment and economic climate can alter.

10 year bond yields

Source: Thomson Reuters Datastream