FOR YEARS, low interest rates have been a boon for the global economy, encouraging consumer spending as well as business expansion. They also drive up asset prices and, in turn, create newfound wealth for many investors around the world.
The ultra-low interest rate environment, which has been kept in place by major central banks around the world since the global financial crisis of 2008, has kept the US economy on an unusually long expansion cycle. Since the trough in June 2009, the US economy will have expanded for 108 consecutive months by the end of this month. This will be the second longest expansion cycle on the record. In fact, if the current cycle extends to July 2019, it will mark the longest expansion in history!
Thanks to Trump’s tax cut and synchronised global economic growth, 2018 will likely see US GDP growth accelerating to near a 3 per cent level. As their economies strengthen, central banks have usually guided interest rates up in order to prevent overheating, and thus avoid the dangerous hyperinflation that could follow.
Rising interest rates will act to slow the economy and, hence, as interest rates rise to a certain level, the economy cools and enters a contraction phase. Recession, by definition, is a matter of “when” not “if”.
For a long time, economists have been looking for early signs of recession and they found the “yield curve” a reliable predictor of coming recession. In an economic expansion phase, the yield curve is normally “upward-sloping”, meaning longer-term bonds are paying higher interest rates than shorter-term ones.
But as the economy approaches the contraction phase, the yield curve will “invert”, with interest rates on longer-term bonds falling below those of shorter ones). Every recession since the late 1950s has seen the yield curve invert before a downturn.
The good news is that the yield curve has not yet inverted in this cycle. But the bad news is the yield curve is now flattest since 2007, and it could take only a few more Fed rate hikes for the curve to invert.
Assuming that the Fed will raise interest rates once every quarter until the end of 2019, the projected path of the US 2-year bond yield will reach 3 per cent by early next year. If US 10-year bond yield stays at the current level of around 3 per cent, then the yield curve could invert in the first quarter of 2019.
On average, recession occurs around 15 months after the yield curve inverts. That means recession could arrive as early as the first half of 2020. Predicting a recession is always difficult, if not impossible. Nonetheless, prudent investors should start thinking about an investment strategy to cope with such a possibility. Because one thing is certain – this cycle will end at some point.
Contributed by KOMSORN PRAKOBPHOL, head of strategy at Tisco Economic Strategy Unit. |He can be reached via www.tiscowealth.com or firstname.lastname@example.org.