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20 Apr 2022

Econ Digest

Is an inverted yield curve a harbinger of recession?

คะแนนเฉลี่ย

        In early April 2022, the U.S. bond market experienced an inverted yield curve. While an inverted yield curve is not always a harbinger of a recession, it is still one of the factors that reminds investors to carefully assess the direction of their investments amid the risks of a future recession due to the many negative factors currently facing the U.S. and the global economies. So, has there been an inverted yield curve in the Thai bond market? Let’s find out together.

        What is an inverted yield curve? An inverted yield curve is a situation in which short-term bond yields are higher than long-term bond yields. It is theoretically used to reflect the market’s perception that short-term economic conditions will face specific problems such as inflation. Thus, short-term interest rates tend to rise with policy rates, and the market believes that inflation or other environmental factors will cause the economy to deteriorate in the long run until long-term interest rates are pressured to fall or rise less than short-term interest rates (during a normal rising interest rate cycle, long-term bond yields should increase in tandem with and above short-term bond yields as compensation for long-term investments). Therefore, an inverted yield curve usually reflects the possibility that the economy will face a recession in the future.

However, this inversion of the US Treasury yield curve is only short-lived, and the possibility of a recession remains low.

        In fact, a historical comparison of 10-year and 2-year bond yields finds that if the difference between 10-year and 2-year bond yields remains negative for a period of time, the U.S. economy would typically experience a recession 1-2 years later. In late March and early April 2022, the U.S bond market saw an inverted yield curve as U.S. inflation pressures rose to the highest level in 40 years. The sharp acceleration in inflation has added to market concerns that the Fed’s rapid rate hike to curb inflation may suppress the future course of U.S. economic growth.

        However, comparing the current situation with the five recessions in the U.S. economy since 1980, it is found that this bond yield inversion has occurred for a shorter period of time, ending on April 5, 2022. Meanwhile, the positive spread between 10-year and 3-month bond yields, which is considered by the Fed as a better indicator of recession risk, is still widening.

        In addition, the market also believes that the probability of a recession in the U.S. is very low. According to a Reuters poll, about 28% of analysts predict that the U.S. economy could face a recession in the next 12 months.

            In retrospect, the U.S. recession cycles associated with or caused by inverted yield curves have typically occurred when U.S. interest rates were near their peaks or in a rate-cutting phase, unlike the beginning of this rate-rising cycle. Therefore, the Fed still has time to closely monitor the economic situation and choose to slow down rate hikes when there are signs of an economic slowdown, in order to reduce the chances and risks of a recession.

For Thailand, the link between yield curve inversion and recession is unclear.
        Thailand has not experienced an inverted bond yield curve since 1999, and even during that period, the Thai economy has faced several recessions. It can be said that in the case of Thailand, the relationship between an inverted yield curve and a recession is unclear. Thailand’s 10-year to 2-year bond yield spread was as small as 0.01% in August 2011, when the Bank of Thailand’s Monetary Policy Committee was raising policy rates to ease inflationary pressures from oil, commodity prices and production costs.

        At present, the slope of the Thai bond yield curve remains positive, with the difference between the 10-year and 2-year bond yields at 1.59% (April 18, 2022). This reflects that Thailand’s short-term interest rate growth still does not have much room to rise and is in line with the Bank of Thailand’s Monetary Policy Committee’s low interest rate policy stance to support Thailand’s economic recovery, even though Thailand is now again facing rising inflationary pressures in line with oil and commodity prices and production costs.

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