A financial crisis on the horizon is increasingly likely to happen: the increase in interest rates has already caused some effects, such as the collapse of several banking institutions such as Silicon Valley Bank (SVB). But the banking collapse may only be the tip of the iceberg; a recent report by Bank of America (BofA) specialists maintains a pessimistic tone and even points out that a deeper crisis could occur throughout this quarter. Specifically, it warns about the levels of yields in the US Treasury bond market.
The inverted rate of treasury bonds, the so-called yield curve. In other words, the interest rates for these assets are higher in the short term (three and two years) than in the long term (10 years), and this worries analysts a lot.
If the interest required for a short-term investment instrument is higher than that requested for a similar long-term onethere is sufficient evidence that a bad economic context is approaching, with interest rates as protagonists. This is not the first time that it has happened, when a similar movement in the bond markets has been registered, later the economic and/or financial crisis has exploded, these are the cases of the years 1990, 2001 and 2008.
In the economy, these recessions have occurred six months after the inverted curve was registered. Therefore, according to Bank of America figures, the inverted curve first made an appearance last November and has not ceased to be present since then, indicating that the crisis should start around May. .
In this sense, the yield curve from 2 to 10 years has experienced its lowest peak for more than 40 years. In addition, there was a worsening in March, when the Silicon Valley Bank collapsed, a fact that reinforces the omen of a crisis for BofA experts.
recession, yeah
For BofA, the yield curve reflects that the recession has already started, although the markets are still waiting for confirmation from the labor market, but there is not much more to pay in this regard.
Likewise, once the recession is already evident, something that perhaps the Fed will wait to confirm in the coming months and hence the expected pause that it will make in the second half of the year, the Fed itself will establish measures to lower interest rates and that there is movement within the financial market. Said action implies an inverted curve that improves long-term expectations, smoothing said curve and reducing its inversion, to eventually reverse the situation of the yield curves.
In this situations, what investors do is buy before the Fed acts so as not to be affected by the reduction in interest rates. A situation that is reflected in the curve and that anticipates the intervention of the central bank.
The increase in interest rates by the central banks for more than a year does not leave much room for manoeuvre, although it was an essential measure due to the increase in inflation. This increase in interest rates is historically one of the causes of economic crises. High interest rates contribute to an bleak horizon for the job market, corporate profits and, consequently, the value of shares.
Bank of America warns in its report issued this week the following: “We remain pessimistic, since the economic ambiguity of 2023 will end with a crack in the labor market and an EPS (earnings per share) recession”, the pessimism remains.
The Fed will speak this week
The Federal Reserve Bank of the United States will determine this week one more movement in the reference rate, so far the consensus expects an increase of 25 basis points. The expectation is also that the Fed will hit its terminal rate, pause for the remainder of the year, and probably start lowering interest rates early next year or towards the end of this year. Everything will depend a lot on what happens in that pause period, that includes the fact that the possible recession is confirmed.. Or a major crisis that forces the central bank to lower the rate to reduce the pernicious effects.
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