Bank of America: Bonds Say 60% Chance of Recession

October 12th, 2011
in econ_news

yield-curve-inverted Econintersect:  Bank of America says that a key bond market indicator indicates about 60% probability of a recession starting within twelve months.  Econintersect has been looking for a precise definition of what this indicator is.  The closest we have come is a statement in an article from Bloomberg (exact quote after continuation break).  In essence the indicator is based on an “adjusted yield curve” which supposedly removes distortions resulting from Fed policy.  (Click on graph for larger image.)

Follow up:

From Bloomberg:

The so-called Treasury yield curve, adjusted for distortions caused by the Federal Reserve's record low zero to 0.25 percent target interest rate for overnight loans between banks, shows that two-year notes yield 20 basis points, or 0.20 percentage point, less than five-year notes, according to Bank of America Corp. research. The unadjusted gap of 79 basis points at the end of last week indicates the chance of recession at about 15 percent.

Short-term rates have been higher than longer-term yields, or inverted, before each of the seven recessions since 1970.

"The adjusted curve is giving a powerful signal for an upcoming U.S. recession," said Ruslan Bikbov, a fixed-income strategist in New York at Bank of America, one of the 22 primary dealers of U.S. government securities that trade with the Fed. "If that happens, the Fed's target rate could remain near zero beyond 2014," more than a year longer than the central bank has indicated, he said in an interview on Oct. 3.

Others have been speaking out about inflation.  Among those who think there is a high probability of recession are ECRI (Economic Cycle Research Institute) and PIMCO’s Bill Gross.  According to Bloomberg, Goldman Sachs puts the recession probability at 40% and and the Federal Reserve Bank of Cleveland puts the odds at 7%.  A JP Morgan analyst, Srini Ramaswanny, says the economy is not falling into recession.

A Bloomsberg quote from Laksman Achuthan, head of ECRI, is quite interesting:

A "contagion" of economic indicators have come together to signal the economy is tipping into a contraction, according to Lakshman Achuthan, co-founder of ECRI, a research firm that predicts changes in the economic cycle.

"You have wildfire among the leading indicators across the board," Achuthan said in a radio interview on Sept. 30 on "Bloomberg Surveillance" with Tom Keene and Ken Prewitt. "It's a vicious cycle that is going to get quite a bit worse."

The EEI (Econintersect Economic Indicator) is close to recessionary levels but has been showing slight strengthen over the past three months.  Econointersect has not declared a recession watch as of the beginning October.  A “watch” is declared when a recession is considered more than simply possible, but becoming likely (close to 50% probable).  The next more serious level for that indicator is a “warning”, indicating a recession is probably (more than 50% likely).  A recession is called when the indicator says a recession has or is about to start and cannot be avoided.

Sources: Financial Advisor, Bloomberg and GEI Analysis

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