Market investors betting on US economic crash later in 2023

By Al Mayadeen English
Source: Agencies
23 Jun 2023 10:31

Market investors have increased their purchase of US short-term bonds as they place high bets on an economic collapse in the coming months.

A pole with a sign pointing toward Wall Street (AFP)

Further interest rate hikes are still highly likely in the United States, despite pausing in the last Federal Reserve meeting, as inflation indicators are still well above the targeted 2 percent.

The rate pause came as inflation reports dropped below the expected target and hit a two-year low.

But the Fed is in a difficult position; raising interest rates risks triggering a recession, while cutting them means inflation will maintain high levels, and may even go higher.

In May, Federal Reserve Bank of St. Louis President James Bullard said an additional two interest rate hikes are expected in the near future, both of them totaling 50 basis points (bps) in all amid efforts to cool down inflation.

"I think we're going to have to grind higher with the policy rate in order to put enough downward pressure on inflation to return inflation to target in a timely manner," he said then.

Market transactions reveal that investors are currently more prone to buy short-term bonds as they place higher bets on an imminent economic crash later this year.

Earlier this week, while 10-year Treasury bonds were at 3.78 percent, two-year bonds were at 4.74 percent, a much more lucrative short-term investment for treasury holders. This trend resulted in what is known as an inverted yield curve; a reverse of normal market trends - which has been the case since April 2022, when the first Fed hike took place to fight inclining inflation rates.

An inverted curve has been the most reliable measure to monitor an incoming recession, signaling an economic crunch within three to six months after the yield's downturn.

But last Wednesday, the spread hit its widest point in three months after Central Bank chair Jerome Powell told the Senate that more rate increases are almost definitely coming.

"Nearly all FOMC [Federal Open Market Committee] participants expect that it will be appropriate to raise interest rates somewhat further by the end of the year," Powell told a Senate committee.

However, while soaring inflation saw a downward trend, consumer prices in several sectors, such as food and gas, remained high which would result in pushing up inflation rates. “Bad things happen when the yield curve is inverted,” said Mike Cudzil, a portfolio manager at an investment management firm Pimco.

“With very inverted yield curves, you tend to see a slowdown in credit creation. This is one reason why a shallow recession by the end of this year, or beginning of next year, is our base case scenario.”

The financial institutions's economists Anna Wong and Eliza Winger forecasted in their recession probability models then that there is was increased probability of recession over all timeframes, during which it will hit a downturn reaching 100% in October 2023 compared to 65% within a comparable period during the 12-month estimate.

According to a separate survey conducted by Bloomberg, 42 economists predict that there is a 60% chance of a recession hitting the country within the next 12-month period, up from 50% in December 2022.

Deutsche Bank chief economist David Folkerts-Landau alarmed in a report following the FOMC statement that "The US is heading for its first genuine policy-led boom-bust cycle in at least four decades.”

The German financial giant estimates that the US economy will slow down for the rest of this year, and expects a recession to take on in early 2024.

Meanwhile, ahead of the FOMC meeting, Goldman Sachs suggested that a US recession scenario has declined, estimated on a 25 percent chance that one triggered in the next 12 months.

The American bank's forecast aligned with that of the Fed, which sees the US economy performing better in the coming month.

The Committee for a Responsible Fiscal Budget CRFB raised that alarm in 2022 that “Excessive borrowing will lead to continued inflationary pressures, drive the national debt to a new record as soon as 2030, and triple federal interest payments over the next decade – or even sooner if interest rates go up faster or by more than expected.”

The latest US abolishment of the debt ceiling until January 2024, means that the United States not only headed toward what the CFRB warned about of "excessive borrowing," but even went down a more dangerous path: borrowing without limit.

It's noteworthy that US inflation surged to a new four-decade high in May of last year, defying hopes that price pressures had peaked and deepening President Joe Biden's political troubles as Americans struggle to meet the cost of essentials like food and gas.