Recession: Beyond the Gloom

Mid Week Bond Update

Recession: Beyond the Gloom

Is the bond market's fear of recession overdone?


The U.S. Treasury yield curve has stoked inflation fears by flirting with inversion since the start of 2019.  And indeed, the New York Fed’s analysis of “term spread” (the difference between long-term and short-term interest rates) would appear to validate those fears:
 

New York Fed Recession Probability Model 12 Months Out, September 30, 2019

Chart courtesy of Brandywine Global. Sources: Federal Reserve Bank of New York/Haver Analytics, October 22, 2019. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

Yet many indicators have been telling a much more positive story about growth along the way. Given that, it’s not altogether surprising that the yield curve has reversed its inversion and is now steepening between 2-year and 10-year yields.

And as noted by Brandywine Global, a sustained rather than a transitory inversion is the true signal of an impending recession: the partial inversions seen earlier in 2019 may simply be a side-effect of years of unconventional monetary policy. Of course, whatever the future may hold, there’s broad agreement that it’s essential that global growth receive continued support from central banks for it to continue.
 

On the rise: U.S. Corporate Issuance

In part because of the lowest investment-grade (IG) spreads in over a year, U.S. corporations have been stepping up their issuance of IG credit, making up for a month-long pause in advance of the current earnings season. Issuers include Hershey, Citigroup and Danaher, with demand for the $1 billion offering from Hershey exceeding the offer size by over six times.

The reason for the pickup: record-low interest rates, translating into bargain borrowing costs. Average spreads reached as low as 1.06 basis point (bps) as of October 28, coming in at a yield of 2.95%, yields not seen in this part of the corporate bond market since the second half of 2016.
 

On the slide: Manufacturing’s Share of the U.S. Economy

At 11.0% of GDP in the second quarter of 2019, the share of the U.S. economy held by manufacturing (as reported by the U.S. Department of Commerce) was the smallest on record since the statistical series began in 1947. That compares with 13.4% for real estate, 12.8% for professional and business services and 12.3% for governments, including federal, state and local.

That’s a significant change for the manufacturing sector, which made up as much as 25% of the economy in the 1960s – notwithstanding the creation of 500,000 jobs in manufacturing since January 2017, when President Trump took office. The upcoming release of GDP figures for the quarter ended September 30 should shed more light on the trend, though it’s possible that the walkout of workers at General Motors could make the underlying trend difficult to interpret.

Note: The year for all dates is 2019 unless otherwise indicated


Definitions:

The yield curve is the graphical depiction of the relationship between the yield on bonds of the same credit quality but different maturities.

Inverted yield curve refers to a market condition when yields for longer-maturity bonds have yields which are lower than shorter-maturity issues.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

The Federal Reserve Bank of New York is one of the 12 Federal Reserve Banks of the United States. It is located at 33 Liberty Street, New YorkNew York.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

Investment-grade bonds are those rated Aaa, Aa, A and Baa by Moody’s Investors Service and AAA, AA, A and BBB by Standard & Poor’s Ratings Service, or that have an equivalent rating by a nationally recognized statistical rating organization or are determined by the manager to be of equivalent quality.

One basis point (bps) equals one one-hundredth (1/100, or 0.01) of one percentage point.

Gross Domestic Product ("GDP") is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.

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