However, nothing has shaken the markets as much as the USA/ China trade war and its subsequent impact on the US Dollar. The looming Federal Reserve rate cut decision and fears of a US economic slowdown, mean that tensions remain high and that the probability of a US recession are ever increasing.
At the commencement of May 2019 there was only a 68% chance of 25-bps rate cuts occurring by the end of the year; the Federal Reserve’s attempt at avoiding a recession, after one of the longest periods of economic grown in the history of the USA. However, according to the Federal funds futures there is now a hugely increased 100% chance there will be a 25-bps rate cut by the end of July 2019. Furthermore, there is a 90% chance there will be a 50-bps interest rate cut by the end of the year and a 51% chance of a 75-bps interest rate cut by the end of the year.
Federal Reserve Interest Rate Expectations Chart (8th July 2019)
So why has this dramatic increase in probability occurred and how can we track the likelihood of a recession in the USA? The US yield curve can be used to predict recessions and the chart highlights the impact the USA/ China trade war has had, which is twofold. Firstly, with the Fed fund pricing looking increasingly as though there will be short-term rate cuts, the short-term end of the yield curve has fallen. Secondly, now that long-term rate cut percentages have risen, the long-term end of the yield call has also subsequently fallen. With both long and short-term aspects of the yield curve falling simultaneously, this has caused a ‘flattening’ of the yield curve to occur and ultimately this could be hugely detrimental to the US economy.
US Treasury Yield Curve Chart (8th July 2019)
A flattening yield curve highlights the uncertainty within the economy and the questions for traders will need to be ‘is the probability of a US recession rising?’ Recession forecasters state that there needs to be a three month period of the yield curve inverting in the 3m10s, in order for a true predictive signal to be determined. This has been an accurate measure of recession since the 1960’s and at present the 3m10s spread is inverted, therefore the possibility of a US recession is rising.
NY Fed Recession Probability Indicator (8th July 2019)
The US recession probability indicator now highlights that there is a 33% chance of a recession hitting the US economy within the next twelve months. Therefore, traders will need to take the following factors into consideration; will the USA/ China trade war deepen, how will the Fed respond to the rate cuts and finally does the trade war tip the global economy into recession? As the forecast remains uncertain traders should anticipate rising volatility in the Forex markets. The next few months are unlikely to be typical trading months and are expected to be slower than usual average summer months.
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This article was originally posted on FX Empire
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