trending Market Intelligence /marketintelligence/en/news-insights/trending/cw5lt0b2MtGuZRbj6AT95g2 content esgSubNav
In This List

Yield curve inversion no guarantee of recession: BIS

Podcast

Street Talk Episode 87

Blog

A New Dawn for European Bank M&A Top 5 Trends

Blog

Insight Weekly: US banks' loan growth; record share buybacks; utility M&A outlook

Blog

Banking Essentials Newsletter 2021: December Edition


Yield curve inversion no guarantee of recession: BIS

Investors should exercise caution in interpreting the recent global yield curve inversion as a harbinger of recession, as other indicators offer a mixed assessment of a potential economic slowdown, the Bank for International Settlements said in its latest quarterly review.

Earlier in the year, yield curves inverted in certain advanced economies, with the spread between 10-year and three-month U.S. Treasury rates dipping below negative 50 basis points in late August.

Long-term government bond yields declined across the globe as escalating trade tensions, coupled with fears of a slowing economy and corresponding accommodative monetary policy actions by central banks, led investors to flock to sovereign debt.

Market participants have perceived the yield curve inversion as an indicator of a looming recession, especially in the U.S., where a negative spread between the 10-year and three-month Treasury rates has preceded every economic contraction since 1973.

However, other recession indicators "paint a less pessimistic picture" of the outlook for the global economy, commented Claudio Borio, head of the monetary and economic department at BIS.

Extra returns demanded by investors to compensate for risks associated with long-term bonds, dubbed term premium, are well below typical pre-recession levels, confounding signals from the yield curve. However, current rate expectations are above those levels, the BIS said. Other indicators also do not yield a clear consensus on recession risk.

In addition, it is unusual to have a combination of negative term premium and an easing monetary policy simultaneously. When the yield curve inverted in the past, the monetary policy stance was that of tightening.

CLOs vs CDOs

"That said, the credit standing of nonfinancial corporations in general, and the surge in leveraged loans in particular, represent a clear vulnerability," Borio said.

Leveraged loans, which have risen in recent years to approximately $1.4 trillion, are now increasingly securitized into collateralized loan obligations, or CLOs. While CLOs are less complex and offer less cause for concern than collateralized debt obligations, or CDOs, the subprime issuance of which played a key role in the global financial crisis of 2008, certain similarities between the two could still give rise to financial distress, the BIS warned.

In particular, the share of low-rated leveraged loans in CLOs has nearly doubled to 18% in recent years and the debt-to-earnings ratio of leveraged borrowers has steadily increased, the BIS said. The concentration of banks' direct holdings of CLOs is also high, with U.S. and Japanese lenders among the largest investors in the asset class, while their indirect exposure remains hard to quantify.

"Losses on these asset classes, and leveraged loans more generally, are likely to amplify any economic slowdown," Borio said.