Recession & US Treasury
Recent Context:
- The United States economy, the biggest and most important economy in the world, has recently been plagued by fears of a recession. The inversion of US Treasury yields is a major indicator that a recession is approaching in the US.
- The definition of a recession comes first and foremost:
- Recessions usually feature the loss of jobs, a decline in overall demand, and a contraction of an economy’s overall output for at least two consecutive quarters. Based on its evaluation of the severity, scope, and duration of the impact on the economy, the US National Bureau of Economic Research (NBER) determines whether the economy is experiencing a recession.
What exactly are American Treasuries?
- Given that they are given to enduring institutions that infrequently default on their commitments, government loans are the safest in any economy. Because their tax revenues don’t always cover all of their expenses, governments frequently have to borrow money. The sale of government bonds is how the government obtains credit from the market. In India, they are referred to as G-secs, in the UK, as gilts, and in the US, as treasuries.
What is a Treasury’s yield?
- As opposed to bank loans, which have interest rates that change over time, government bonds provide a fixed “coupon” payment. The US government is thus permitted to “float” a bond with a $100,00 face value and a $5 yearly coupon.
- This means that if you purchase this bond and loan the US government $100, you will receive $5 annually for the following ten years in addition to receiving the whole $100 at the conclusion of those ten years. This would suggest a 5% yield.
- If the bond were to be sold for some reason to a different investor, the yield would change based on the price paid for the bond. The yield will decrease if the price rises because the annual return ($5) keeps the same, let’s assume the bond sells for $110 instead of $100. Additionally, the yield will increase as the price drops.
The yield curve: what is it?
- The length of a government’s borrowing cycles might range from one month to thirty years. Loans with longer terms often have greater yields because they are made over longer periods of time. – When the yields for various bond tenures are mapped, an upward-sloping curve (labelled “Normal” in the top chart) results.
- Depending on the amount of money on the market and the anticipated level of total economic activity, the curves could be flat or steep. – When the economy is doing well, investors move their money from long-term bonds to shorter-term, riskier investments like the stock market. As long-term bond rates rise and their values decline, the yield curve becomes steeper.
Yield inversion: What is it?
- A yield inversion occurs when the yields on bonds with shorter terms are higher than those on bonds with longer terms.
- Investors will transfer their funds out of hazardous short-term investments like the stock market and into long-term bonds if they believe the economy is in danger. As a result, the price of long-term bonds increases and their yields decrease. The yield curve initially flattens as a result of this strategy before inverting.
- For some time, US treasuries have been exhibiting yield inversion, which has been cited as a reliable indicator of recession in the nation. Three-month and ten-year Treasury bond yield spreads are currently negative.
Does this contain anything shocking?
- The US Federal Reserve has been increasing short-term interest rates to stifle overall demand and economic activity in an effort to limit historically high inflation levels. The US has had a recession each time the Fed has attempted to reduce inflation by more than two percentage points in the past. The Fed has a declared objective of lowering inflation to 2%, but after rapid rate increases of 425 basis points, inflation has only decreased from about 9% in July to 7% in November. In addition, the economy created tens of thousands of new jobs from July through September, improving salaries and maintaining historically low unemployment rates. Therefore, even though the Fed has recently started doing so more gradually, it is anticipated that it will maintain raising rates and sustain them for a longer period of time.
What makes it significant to India?
- The US currency would undoubtedly gain momentum on the Indian rupee if interest rates climb. As a result, Indian imports will cost more, potentially increasing domestic inflation. A rebalancing of the assets coming to India may result from higher returns in the US. While a global recession would reduce demand for Indian products, a weaker currency might help Indian exports. An advantage of a downturn or recession for India, though, might be lower crude oil prices.
