RISK OF RECESSION IN 2020 EXACERBATED BY CRUDE OIL PRICE CRASH & CREDIT CRUNCH AS CORONAVIRUS CONCERNS BUILD
- Recession risk could be ratcheting even higher after the price of crude oil crashed over 20% in a single day
- Odds of a recession this year have likely risen again amid another spike in credit default risk on high-yield corporate bonds
- The novel coronavirus outbreak has wreaked havoc on the global supply chain and contributed to a contraction in US business activity
Panic-struck stock market investors seem to have taken notice of the rising likelihood that we are going into a recession in the not-too-distant future. A staggering selloff across global equities over recent weeks, driven initially by expected economic fallout from the coronavirus, has gained pace after the latest destabilizing black-swan event: a crash in crude oil prices.
RECESSION RISK BACK ON THE RISE – PROBABILITY OF US RECESSION PREDICTED BY TREASURY YIELD CURVE SPREAD
According to the Federal Reserve, the probability of a US recession occurring over the next 12-months, as predicted by the Treasury yield curve spread, was clocked at 31% on February 28. Although distressed credit markets caught a breather following an emergency Fed rate cut last week, its first since the global financial crisis and collapse of Lehman Brothers, the 10-year and three-month interest rate spread (3m10s) on US Treasuries took a 20-basis point tumble in response to the latest crude oil price crash.
US TREASURY YIELD CURVE HEADED BACK TOWARD INVERSION TERRITORY ON TEN-YEAR LESS THREE-MONTH SPREAD
The 3m10s US Treasury yield curve spread now stands at a positive 18-bps, but this popular recession gauge appears to be headed back toward inversion territory. This might follow rising default risk on high-yield US corporate debt, which presents contagion risk to the broader financial system and economy.
CRUDE OIL PRICE CRASH ADDS TO STRAIN ON CREDIT MARKETS & RAISES DEFAULT RISKFOR HIGH-YIELD CORPORATE DEBT
In fact, the options-adjusted spread (OAS)above the risk-free rate of return for high-yield corporate debt exploded higher to 5.5 percentage points as of March 06 – prior to the 30% gap lower in crude oil just witnessed. With crude now trading around $30.00/bbl, far below the approximate $50.00/bbl break-even price for US shale oil producers, fund outflows have soared from the iShares High Yield Corporate Bond ETF (Ticker symbol: HYG), which has over 10% of its market value exposed to poor credit quality energy companies.
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Likewise, countries heavily dependent on oil exports like Canada or Mexico have seen their currencies plummet relative to safe-haven currencies like the US Dollar and Japanese Yen. At the same time, the broader US Dollar Index (Ticker symbol: DXY), which is heavily weighted to EUR/USD performance, has cratered to an 18-month low as the Euro gains ground against the Greenback.
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Selling pressure in the USD was sparked amid rekindled recession odds following the IHS Markit PMI report for February, which detailed a contraction in US business activity, and notably the services sector, to a 76-month low. As such, it seems likely that recession risk has intensified alongside growing coronavirus concerns and adverse effects from a crash in crude oil.
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