Analysts at the data analytics firm have highlighted a strong correlation between US Treasury yields and Bund yields in Europe. Both yields have experienced declines in recent weeks as market participants adjust their short-term interest-rate expectations. This correlation, as observed during the Silicon Valley Bank crisis in early 2023, suggests that the US economy might be on the brink of a recession, especially given the likelihood of European central banks swiftly cutting interest rates in response to a downturn in the US.
The close relationship between US and European bond yields, which currently exhibits a significant elevation, typically indicates a narrative of a hard landing, the analysts explained. They emphasized that in the event of a severe recession or a major economic disruption in the US, the European Central Bank (ECB) would likely respond promptly.
However, despite these warning signals, US investors remain optimistic about both the markets and the economy. This optimism is fueled by expectations of interest rate cuts by the Federal Reserve later in the year. While central bankers have projected a 75 basis points reduction by the end of 2024, market participants anticipate an even more aggressive easing, with a 60% chance priced in that the Fed could lower rates by at least a full percentage point by December. ING suggests that such expectations point towards a soft landing scenario.
The analysts anticipate that the tight correlation between Treasury and Bund yields may weaken in the future, allowing European markets to shift their focus from the Fed's narrative to that of the ECB. Despite this, economists caution that recession risks persist, particularly as the labor market appears poised to weaken. Additionally, there is a concern that inflationary pressures could lead to prolonged higher interest rates, potentially causing the Fed to overtighten and push the economy into a downturn.
Based on economic models, there is now an 85% chance of the US entering a recession, marking the highest probability since the Great Financial Crisis. New York Fed economists are also pricing in a 61% chance of a recession by January of the following year.
