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How Fears of an Inverted Yield Curve Could Be Self Fulfilling

How Fears of an Inverted Yield Curve Could Be Self Fulfilling
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Monday, 09 July 2018 08:38 AM

Bankers may be their own worst enemy.

A “self-fulfilling” spiral is threatening the business cycle, whereby lenders fretting economic doom from an inverted U.S. yield curve pull credit -- and by their own actions derail growth.

And the dynamic could be set in motion as early as this year.

That’s the warning from Mark Holman, chief executive officer of TwentyFour Asset Management, a London fixed-income fund overseeing 13.5 billion pounds ($18 billion).

“Every recession has been precursed with commercial banks tightening credit,” he said in an interview. “Even more important potentially than central banks is tightening by commercial banks.”

Short-term yields have climbed this year on the back of faster growth, expectations of interest-rate increases and an uptick in Treasury bill supply.

The two- to 10-year yield spread has fallen to less than 30 basis points, the narrowest since the summer of 2007. That’s spurring fears of an oncoming inversion of the cash curve, a dynamic which has preceded the majority of all U.S. recessions in recent decades.

As the vanishing spread feeds market fears, private banks ironically may be the proximate cause for disrupting the economic expansion, according to Holman.

“The second the yield curve goes flat, every major bank will be telling you recession is so many months away," he said. "An inverted yield curve could easily happen before the end of the year.”

Already, JPMorgan Chase & Co. is providing clients with advice on ways to insulate investments against a recession, suggesting the U.S. dollar and Japanese yen are safest.

For now, credit growth and lender profits are in rude health amid buoyant demand while treasurers are hedging interest-rate risks. Banks are also generating billions of dollars in trading income as well as fees and commissions amid capital-market activity like mergers and acquisitions.

But the theory goes that a completely flat, or inverted, curve will depress net interest margins soon enough -- imperiling credit growth -- just as the U.S. expansion looks long in the tooth.

"It’s getting toward the end of the cycle," said Holman. "The banks aren’t idiots -- they’ll be looking to offload the worst credits.”

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Bankers may be their own worst enemy.A "self-fulfilling" spiral is threatening the business cycle, whereby lenders fretting economic doom from an inverted U.S. yield curve pull credit -- and by their own actions derail growth.And the dynamic could be set in motion as early...
inverted yield curve, fears, stocks
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2018-38-09
Monday, 09 July 2018 08:38 AM
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