Global economy heading toward recession

February 20, 2016 08:04
Consumers’ purchasing power will be affected if they receive a negative return from bank deposits. Photo: Xinhua

Investors are suffering losses amid volatile financial markets and gloomy economic prospects.

And their confidence has been shattered, too.

Should we just leave the market? Is there any opportunity to make money?

In fact, we are facing two tricky issues at the same time.

The economy is already in, or will fall into, a recession.

Second, unconventional monetary policy or quantitative easing, which has underpinned rising asset prices in the last seven years, will come to an end.

The question is whether we have any new tricks.

There are so many debates among economists and financial analysts on whether the economy will slip into recession.

I will review the future market direction based on the yield curve of US treasury securities.

The balance sheet of the US Federal Reserve has spiked to US$4.5 trillion from US$800 billion after several rounds of QE since the 2008 financial crisis.

The federal funds rate was raised to 0.5 percent in mid-December. It was the first US rate hike in over seven years.

In the meantime, other major central banks, in Europe, Japan and China, are still launching monetary easing measures or have even adopted a negative interest rate policy.

Historical experience shows us that the yield curve is usually steep when the market moves into the rate hike cycle, where long-term yields are higher than short-term yields.

By contrast, we will see an inverted yield curve if the market is in the middle of a rate cut or deflation cycle.

However, the yield on 10-year US treasury bonds has dropped from 2.2 percent last month to 1.7 percent at present.

That is quite abnormal.

The credit spread between 10-year treasury bonds and three-month treasury bills remains at 1.42 percent, close to the average level of 1.5 percent.

It’s worth noting that the short-term rate has been kept at historically low levels for more than seven years.

That has distorted the market considerably.

And the Fed’s five-year forward inflation rate has tumbled to a low of 1.5 percent.

In that sense, a global economic recession is already looming.

What should we do?

Everyone is looking to central banks and governments in the hope that there will be massive monetary or fiscal stimulus measures like those we saw in 2008.

In fact, several central banks in European countries and Japan have already imposed negative interest rates.

And the Fed also hinted that it is likely to consider negative rates to counter another economic slump.

It seems that the negative interest rate is the last trump card for central banks. Will it work?

I don’t believe a negative interest rate will prompt investors to put money into risk assets and create more demand for loans.

It all depends on risk and reward. Each coin has both sides.

Consumers’ purchasing power will be affected if they receive a negative return from bank deposits or pension funds.

This article appeared in the Hong Kong Economic Journal on Feb. 18.

Translation by Julie Zhu

[Chinese version 中文版]

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head of private banking and trust services at Hang Seng Bank