JPMORGAN: Coronavirus fears are causing the bond market's biggest shake-up since the financial crisis. Here's a novel strategy to prepare for future turmoil and detect the next recession.
- Credit markets have "taken a life of their own" and are implying a whopping 80% chance of a recession within the next year, according to JPMorgan.
- The bank's head of US interest rate derivatives strategy has uncovered an additional signal that has presaged prior economic-growth downgrades.
- Click here for more BI Prime stories.
The Fed's emergency rate cut was not the only unusual occurrence in the fixed-income market on Tuesday.
Observers of interest rates - from potential home buyers to bond traders - would have also noticed the plummet in Treasury yields. The 10-year yield, for example, fell to an all-time low of 0.91% as coronavirus fears persisted even after the Fed's rescue effort.
To further quantify the bond market's moves, derivatives strategists at JPMorgan noted that traders repriced short-term yields on a volatility-adjusted basis at the most violent pace since the depths of the 2008 crisis.
Treasuries are likely to stay in demand - thereby keeping yields low - for as long as the coronavirus has investors on edge. And according to JPMorgan, there's a quirky yet empirically sound way to figure out the future path of yields.
But first, it is important to consider the bond market's big move in its broader context: what is it signaling about the economy?
The answer is a nearly 80% chance of a recession during the next year, according to Joshua Younger, JPMorgan's head of US interest-rate derivatives strategy.
Those odds are remarkably higher than what raw data is implying because the US economy has not materially deteriorated since the coronavirus began to spread.
But in Younger's view, the bond market's warning signal should not be taken lightly.
"Markets indeed appear to have taken on a life of their own, re-pricing expectations much more rapidly and significantly than can be justified by broader measures of sentiment, and especially relative to economic data," he said in a recent note to clients.
In other words, markets are sniffing out trouble that the hard data has yet to confirm.
With that in mind, he noted that the tone of macro research sentiment has actually been predictive of moves in interest rates. That means if you track sentiment, you can anticipate what happens next in the bond market, and what that pricing says about the economy.
Younger specifically uses JPMorgan's Research Duration Sentiment Index, which deploys natural language processing techniques and machine learning to understand the sentiment in macro research notes and anticipate moves in the 10-year yield.
"It is also worth noting that, in the past, medium-term shifts in macro research sentiment have presaged growth downgrades in subsequent months (e.g., 1-year ahead consensus GDP forecasts, on a 3- to 6-month lag)," Younger said.
He concluded: "We have already seen several such revisions, for example in EM Asia, Japan, Western Europe, and the US. To the extent that the tone of macro research remains bullish for Treasuries and points to the risk of further downgrades to global growth expectations, it should serve as yet another headwind against higher yields."