US bond yield movement flags recession fears

ET Intelligence Group: Equity as an asset class, which has been under pressure after losing more than $12 trillion of market value globally this year, could witness more headwinds as recession indicators have started flashing warning signs.

The difference between the 10- and 2-year treasury yields in the US, a widely-acknowledged recession indicator, is just 20 basis points away from turning negative. A year ago, this was 140 basis points on the positive side. The higher yield on 30-year US treasury bonds over the five-year paper shrank to just 12 basis points, the narrowest in 15 years.

Yield inversion of 2- to 10-year bonds had accurately predicted recession in the past 60 years. Ten of the 13 past recessions had been preceded by the 10-year rate falling below the 2-year rate.
When the yield on the short-term bond surpasses that of the long-term paper, it is called an inverted yield curve and this phenomenon typically presages a recession. Historically, it has been observed that US recession has occurred within 12-24 months after the first sign of inversion. In the early cycle of yield inversion, the equity market tends to head southwards as investors prune their exposure to risky assets.

With increasingly hawkish comments from the Federal Reserve, the money market has started predicting that the US central bank may increase rates by 200 basis points, or 2 percentage points, in 2022 and baking three-in-four changes of 50 basis points increase by Fed's next meeting in May 2022.

The two-year bond yield in the US has gained 145 basis points since the beginning of 2021 to reach 2.14% and is on course to be the fastest quarterly gain in March since 1984. The rising bond yield, or the fall in bond price, signals either a slowdown in the economy or even a recession.

This has sent ripples across the bond market in the last few days. The Bloomberg Global Aggregate Index - a measure of government and corporate debt returns - fell 11% from its high in January 2021, the sharpest decline since its peak in 1990 and even more than its 10.8% drawdown during the 2008 global financial crisis. This translates into around a $2 trillion drop in the market value of the debt index.