Read tea leaves in the market to know the risks of global recession

A Wall Street sign outside the New York Stock Exchange in New York City, New York, US, October 2, 2020. REUTERS/Carlo Allegri // File Photo

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LONDON (Reuters) – The fastest rate hikes in decades and near double-digit inflation have investors looking for market action and data to gauge whether the global economy is heading into a recession.

Business activity is slowing, and many stock indexes are in “bear” territory, while higher borrowing costs are putting pressure on business and consumer spending.

Last week, the US Federal Reserve raised interest rates by 75 basis points, its largest single hike since 1994, and signaled its commitment to containing price pressures even if it depresses growth. Read more

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“Inflation is still rising and that means the Fed will rise more and move more quickly, which will put downward pressure on the economy, adding to recession fears,” said Sima Shah, chief strategist at Principal Global Investors.

“There are also increasing signs of economic weakness coming sooner than expected.”

The World Bank is currently forecasting global growth in 2022 at 2.9%.

Here’s what some closely watched indicators say about the risks of a recession.

1 / Old favorites

The US Treasury yield curve has a proven track record of predicting recessions, especially when two-year bond yields are higher than 10-year maturities.

At around 5 basis points (bps), the spread between these two segments has moved in and out of negative territory recently, so recession watchers are taking note.

The worry is that the Fed, which faces 8% excess inflation, will take monetary policy into what economists call restricted territory, slowing economic activity.

“The chances of the Fed landing on this narrow strip of safe ground are very remote,” said Colin Asher, chief economist at Mizuho.

After money markets lowered their bets on how high interest rates the Fed would take, they now expect rates to fall by about 20 basis points between April and July 2023. Read more

2/ PMI problems

Purchasing Managers’ Indexes (PMIs) are reliable indicators of manufacturing, services, inventories of merchandise, new orders, and therefore future growth.

JPMorgan’s global composite PMI was the weakest since July 2020 in May, with only the new orders component above 50 that splits activity expansion from contraction.

US PMIs also fell, with manufacturing slowing sharply in June. The sub-50 readings coincided with recessionary periods in 2008 and 2020.

“Global PMIs slipping toward 50 are another sign that the post-COVID boom is behind us,” said Mizuho’s Asher.

3 / Calculation of goods

Copper, a well-known growth leader, is down 7% this week – its biggest weekly drop since the crash in March 2020.

Dubbed “Doctor Cooper” due to its record as a boom and bust, the metal has also seen its price-to-gold ratio reach an 18-month low. In short, if you think the economy is shrinking, ditch the copper and buy gold.

Brent crude also fell 10% in June and is set to post its biggest monthly drop since November.

4 / Take care of the junk

Corporate sector pressure, especially at the lower end of the credit scale, is another warning signal.

Funding costs for sub-investment companies, or “junk” US companies, have nearly doubled this year to 8.51% (.MERH0A0). In the euro markets, yields rose to 6.8% from 2.8% (.MERHE00).

According to BofA, if a recession becomes a consensus view, the risk premium on junk bonds in the US will be 600-650 basis points, peaking above 700 basis points.

At current spreads of 500 basis points, the index is “close to 70% on our way to assured pricing for the outcome of a recession,” Bank of America analysts wrote.

Spreads on bonds rated triple C and lower – which face the highest risk of default – have risen above 1,000 basis points, an important sign of stress. (.MERH0A3), (.MERHE30)

5/ Transfer compatibility

Many major banks are undermining the possibility of a growing recession.

Goldman Sachs forecasts a 30% chance of the US economy entering recession over the next year – versus 15% earlier – while Morgan Stanley puts the odds of a US recession for the next 12 months at around 35%. Read more

Citi predicts the probability of a global recession is close to 50%.

The Citi Surprise Economic Index, which measures the degree to which data is outstripping or missing expectations, fell sharply in both Europe and the United States.

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(Covering) Written by Dara Ranasinghe, Sujata Rao and Yoruk Bhajeli, Editing by Catherine Evans

Our Standards: Thomson Reuters Trust Principles.

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