Recession concerns that had seemed to have subsided only a few weeks earlier have been re-ignited by the failure of American lenders Silicon Valley Bank (SVB) and Signature Bank, followed by Credit Suisse’s rescue, and the accompanying turbulence in global markets.
The Federal Reserve is almost done raising interest rates, according to traders. Early this year, the optimism that followed China’s economic opening and falling energy prices has faded.
“The bigger, medium-term implication, of what’s happened in the last month is that global growth will be far weaker in six months than we thought even just a few weeks ago,” said Mike Riddell, senior fixed income portfolio manager at Allianz Global Investors.
Here are some carefully observed market indicators that speak to the likelihood of a recession:
The potential for financial stress to cause a credit crisis is being actively watched by central bankers in addition to the already tighter lending standards.
Jerome Powell, the head of the Fed, thinks that financial conditions have likely tightened more than what conventional measurements suggest. Christine Lagarde, president of the European Central Bank, has said that the market turbulence may contribute in the fight against inflation.
According to Goldman Sachs, the expected tightening of bank lending requirements could reduce 2023 U.S. economic growth by at least 0.25 to 0.5 percentage points, which is similar to the effect of an additional 25 to 50 basis points of Fed rate hikes.
Gilles Moec, the chief economist at AXA Investment Managers, pointed to statistics from the Fed that showed bank asset and liability balances as of March 15 and highlighted that both small and large U.S. banks were borrowing excessively and holding onto cash.
“There is a sizeable risk that the ongoing banking trouble triggers a ‘sudden stop’ in lending which would then send the economy into the sort of recession which would go beyond what is strictly needed to tame inflation,” he added.
With almost 50 basis points worth of rate reduction priced by year’s end, traders were wagering on Tuesday that another Fed rate hike is a coin flip as the outlook grows gloomier. Rates at the ECB are anticipated to peak at roughly 3.4%, down from above 4% in early March.
Shorter-dated borrowing costs have decreased as a result. U.S. two-year bond yields have decreased by 80 basis points in March, resulting in a less inverted yield curve than before the collapse of SVB.
Although inverted yield curves, where longer-dated borrowing costs are lower than shorter-dated ones, are good indicators of impending recessions, inversion has historically been followed by steepening.
This month saw the largest monthly steepening of the U.S. two-year/10-year yield curve since 2009.
Although if global stock markets are still up this year and only experienced a 0.1% decline in March, there are growing concerns below the surface.
Prior to the turmoil, international bank stocks had outperformed the MSCI World Stock Index, but this month they have dropped by almost 15%. Real estate and the oil and gas industries, which are sensitive to the growth outlook, are currently performing poorly.
The risk premium on corporate debt has also increased as a result of the banking problems. For instance, between March 9 and March 20, euro high yield spreads relative to risk-free rates increased by 140 basis points.
Nonetheless, such spreads are still much below the highs achieved last year and substantially below the levels experienced during the 2020 COVID-19 pandemic, indicating that concerns about a credit market recession are quite minimal.
Due to its track record as a boom-bust indicator, copper is known as “Doctor Copper,” and it has increased 7% so far this year. Yet, it has lost some of its early-January vigor due to market uncertainty and the fact that after its re-opening, demand from China, the world’s largest consumer of commodities, hasn’t soared as anticipated.
The price ratio of copper to gold, which is used to measure risk appetite, fell to its lowest level in almost seven months in March as investors fled riskier investments in favor of safe haven assets.
According to a Citi indicator, data are still producing positive surprises at the greatest pace since May 2022, indicating that the economy is not yet flashing a recession warning.
In contrast, corporate activity in the US and the euro zone increased in March more quickly than anticipated.
“The (U.S.) data was largely collected after SVB’s collapse, which suggests that the initial negative impact from uncertainty has been modest,” said Kristoffer Kjær Lomholt, head of FX, corporate research and chief analyst at Danske Bank.
(Adapted from Latestly.com)
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