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Investing.com – Bank of America (NYSE:) strategists said in a recent note that U.S. inflation could drop significantly in the coming period, and prices could cool significantly without the U.S. having to enter a recessionary tunnel.
Strategists pointed out that this is due to the inverted 2-year and 10-year yield curves, an infamous bond market stagnation measure that has successfully predicted many downturns, most recently in 1990, 2001, 2008. When short-term yields rise above long-term bond yields , that becomes a historic signal that investors believe a downturn is coming.
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Historical reflection
The spread between the two- and 10-year Treasury yields fell to a full percentage point last week, marking the biggest reversal in more than 40 years.
The bank said that this time the index more reflects a strong upcoming decline in inflation itself, not the economy. Bank of America believes that the US economy is still avoiding a sharp recession.
“While the inversion of the curve near the historical extremes has indicated higher recession probabilities than models, we believe the shape of the curve is more indicative of lower inflation expectations than of a deterioration in growth,” the strategists said in a note issued on Thursday.
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recession and interest rates
“The curve also indicates that real forward rates do not price higher recessionary risks and instead may reflect softer downside expectations in the economy,” the note added.
The bank said that’s because forward real yields, which represent market expectations for inflation-adjusted bond yields, have seen only a “modest decline” in the short term.
It also suggests that investors expect the Fed to cut slowly, a move they are unlikely to do “slowly” if the economy faces particularly high risks of recession.
The strategists added that “the inversion of the curve at historically extreme levels does not currently reflect elevated recession risks, but is largely related to expectations of interest rate cuts, along with inflation converging on target,” referring to the federal inflation target of 2%.
Investors have been eyeing a potential recession for the past year as the Federal Reserve aggressively raised interest rates to tame inflation, a move that threatens to tip the economy into recession.
Interest rates are now at their highest level since 2007, with Federal Reserve officials suggesting that more rate hikes are to come later this year.
Another is at the July policy meeting, a move that would raise the federal funds rate to 5.25-5.5%.
Meanwhile, the New York Federal Reserve has priced in a 71% chance that the economy will slip into recession by next year.
2023-07-03 07:34:00
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