US recession fears bring uncertainty, volatility to global markets

M’sia posted 2 consecutive months of deflation in January and February on low petrol prices


Weaker global economic growth could well be on the cards in the near future as financial markets’ most reliable indicator of a recession — an inversion of the US Treasury yield curve — has finally happened after more than a decade.

The US Treasury yield curve last Friday inverted for the first time since 2007 and just prior to the 2008 financial crisis, when a jump in buying boosted the 10-year Treasury yields to a 14-month low of 2.416% and eliminated the gap between the 10-year and the three-month yields.

Investors were spooked by the omen of financial doom in the US, as the yield curve inversion — whereby the yield on long-term notes fell below that of short-term securities — has happened before each of the past seven recessions over the last 60 years.

Recession fears are further worsened by a third straight month of slowing manufacturing output data in Germany, while manufacturing and services activity for March appear to have grown less than in February, according to preliminary gauges.

“Empirically speaking, it takes about 12 months to 27 months for the US economy to be in recession once the yield curve inverts. As such, we can expect financial markets — especially equities — to be more cautious going forward,” Bank Islam Malaysia Bhd chief economist Dr Mohd Afzanizam Abdul Rashid told The Malaysian Reserve (TMR).

On what could actually trigger a recession, he pointed to the trade tensions between China and the US, as well as concerns surrounding higher indebtedness among American corporates following a protracted period of a low interest-rate environment.

“In a nutshell, the cautious view is warranted and therefore, demand for fixed-income securities would be higher going forward,” Mohd Afzanizam said.

Aberdeen Standard Investments (M) Sdn Bhd country head Gerald Ambrose concurred, noting that there are many factors at play in addition to the yield-curve inversion, such as low bond returns globally.

“It is a pretty bad sign and has forecast a lot of the past recessions. Many people also aren’t entirely convinced by the run-up in equity markets since December last year. Plus, the US Federal Reserve (Fed) said in October that interest rates would continue to rise and quantitative tightening would continue, then turn around completely within a month.

“It’s the uncertainty that has led people to think they’re not sure about the state of the economy. Economic and export data from Europe are also not very positive,” Ambrose told TMR.

He added that the path of quantitative easing taken by developed nations after the last financial crisis hasn’t quite worked out as expected.

“Here we are, 10 years and three stages of easing later, trying to get back to where we were before the crisis, and we failed. As soon as markets start showing discomfort, it appears that central banks worldwide have to backpedal,” Ambrose said.

Political and trade tensions continue to impact investor sentiment with delays in Brexit negotiations, while US-China talks remain on their on-again, off-again trajectory.

Mohd Afzanizam added that there is a positive correlation of about 80% between Malaysian and US GDP growth, thus anything that happens to the US growth trajectory would affect Malaysia almost directly.

Nonetheless, policy intervention such as monetary easing and fiscal pump priming will ensure domestic demand can be sustained, while offsetting weaknesses emanating from the external sector.

“The case for a lower Overnight Policy Rate (OPR) is building up. We have seen weak business sentiments from the Malaysian Institute of Economic Research, RAM Rating Services Bhd, IHS Markit and the Department of Statistics Malaysia. And there is a deflationary trend going on over the past two months which gives more space for Bank Negara Malaysia (BNM) to reduce the rates,” he said.

Economists are expecting BNM to cut the OPR this year, given the Fed’s increasingly dovish monetary stance which is pushing central banks globally to lean towards more neutral or softer monetary policy bias.

Malaysia also recorded two consecutive months of deflation in January and February this year on low petrol prices, adding to the possibility of a rate cut to sustain economic growth.

The country last experienced deflation in 2009 following the global financial crisis during an economic recession.

Slashing interest rates could do more harm than intended as the move would pose a currency risk, Ambrose cautioned.

“Cutting rates might affect the ringgit’s strength against other currencies. There was negative inflation seen in January and February, but that had nothing to do with weak demand in Malaysia or recessionary factors — it was related to low petrol prices. So, cutting interest rates won’t really stimulate demand because that’s not the problem. The demand is there,” he said.

JPMorgan in a note yesterday called the bond market price action “an enormous blaring siren” to anyone attempting to be optimistic on stocks, as investors flee for low-risk assets such as bonds and the Japanese yen.

“Growth and bonds/yield curves, will be the only thing stocks should be focused on going forward, and it’s very hard to envision any type of rally until economic confidence stabilises and bonds reverse,” it said.