Revisiting recession fears amid falling yields

Recession fears among investors have eased as equity markets post solid performances this year. Yet, the bond market seems to signal a different story.

In Canada, “for the first time in over a decade, we have a full-on yield curve inversion,” said BMO chief economist Douglas Porter in a weekly financial digest. He was referring to yields as of March 15, when the 10-year government of Canada bond yield was 1.71%, below the Bank of Canada’s overnight rate of 1.75%.

Further, the five-year bond has “plummeted,” Porter said, with yields at 1.6% since peaking at nearly 2.5% last fall. The 30-year bond yield is nearing 2%—a record 100-basis-point spread versus like-dated U.S. yields.

While Porter called these yields a warning signal, he said the underlying economic backdrop doesn’t point to dire circumstances. “Always remember that recessions are actually quite rare events, and it takes a lot to tip an economy into a full-scale recession,” he said in the report, adding that expansions can continue for many years. For example, Australia is working on a record 27 years without a recession.

Still, Porter acknowledged that economic growth is a struggle, with forecasts for global growth recently downgraded. BMO’s global growth forecast is 3.3% for 2019, down from last year’s 3.6% rate, and its prediction for Canada is 1.3%. (Similarly, consensus on Canada’s growth is 1.4%, a drop of 0.6 percentage points since late last year.)

While Canada’s first-quarter growth has been challenged by oil production cuts and a harsh winter, Porter expects growth will improve “modestly” going forward, amid stronger oil prices, an easing of oil production cuts and, potentially, fiscal stimulus from Tuesday’s federal budget.

In a report released this month, TD senior economist Brian DePratto said that, barring a “severe external shock,” the Canadian economy is, at most, at risk of a technical recession, defined as lacking the depth, breadth and duration to mark a true recession.

A true recession has “effectively never occurred in history without a matching contraction south of the border,” DePratto said in the report. Consensus for U.S. growth this year is 2.4%, a modest drop from 2.7% last fall.

To assess the ongoing risk of a downturn, DePratto said key areas to watch include credit growth and labour markets.

For example, consumer and mortgage credit are trending lower, with the latter impacted by changes to mortgage rules implemented last year.

And, while the labour market has been a bright spot, with Canada exhibiting strong jobs growth over the last year, wages have decelerated—in part due to oil sector weakness—and aggregate hours worked fell in December and January.

While wages should accelerate with the oil rebound, the drop in hours worked can be an early sign of economic weakness, DePratto said. However, the current measure remains “well within historic norms,” he added.

Porter offered a final insight about the Canadian economy as oil prices strengthen: tame inflation readings could soon come to an end. While headline inflation is holding steady at about 2%, inflation’s pace will “soon reassert itself in the headline measure if oil prices remain firm,” he said.

For full details, read the reports from BMO and TD.

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.