Recession is the word of the day after an important warning sign was triggered on the markets.
Last night the yield on two-year US government bonds rose above that of the 10-year note, causing an inverted yield curve – something that has historically preceded a recession.
Traditionally investors demand a higher return and therefore a higher yield on longer dated bonds than shorter dated ones as compensation for the greater risks from inflation and issuer default.
Therefore, to see higher yields on shorter dated bonds versus longer-dated ones is less common and hence why investors sit up and take notice when it happens. Yesterday’s event was the first time it has occurred with US Treasuries since 2019.
“Investors shouldn’t be surprised at the recession warning given the soaring cost of living and how inflationary pressures threaten to dampen economic activity,” said Russ Mould, investment director at AJ Bell.
“Central banks have already started the typical course of action when you have high inflation, namely putting up interest rates. They will need to walk a careful path, not being too aggressive with the pace and scale of rate rises so that it chokes off the economy. The US Federal Reserve is being watched the closest as there appears to be a growing risk that it does too much too fast.
“Despite a healthy jobs market and resilient consumer spending of late, stock markets have already been pricing in an economic hit later this year. For example, just look at the sharp decline year to date in UK consumer-facing stocks such as retailers and restaurant operators. It doesn’t much to realise that more expensive energy, food and fuel bills will eventually cause consumers to think twice before spending money.
“While US markets last night enjoyed another strong session, with the Nasdaq up 1.8% and the S&P 500 up 1.2%, European equities didn’t fare as well on Wednesday after the recession signal on the bond market.
“The Dax traded 0.8% lower, the CAC 40 fell 0.6% and the Ibex 35 slipped 0.5%. The outlier was the FTSE 100 which pushed ahead by 0.2% thanks to strength in miners and oil producers.
“The fallout from the Ukraine war continues to affect companies in the Western world. The latest businesses to quantify the impact include computer games maker Team17.
“Uncertainties around the release date of two games developed with partners in Ukraine and the decision to close platform sales to Russia and Belarus means Team17 says it will incur a £4 million hit to sales and £2.5 million hit to earnings in its current financial year.”