- The investment community have watched the recent trend in bond yields this year, with many commentators predicting that the current economic cycle could be reaching a peak.
- The "flattening of the yield curve" — where short-term interest rates get closer to the long-term rates — has sparked some fears that a recession is around the corner.
- But, according to Bank of America Merrill Lynch, we are not there yet.
Bank of America's investment arm has offered some soothing words to investors fretting about an imminent meltdown in global equities and a resulting slowdown.
The investment community have been busy watching the recent trend in bond yields this year, with many commentators predicting that the current economic cycle could be reaching a peak. The "flattening of the yield curve" — where short-term interest rates get closer to the long-term rates — has sparked some fears that a recession is around the corner. In a normal functioning economy, short-term lending has fewer risks — the underlying thought is that you can more easily predict what's happening tomorrow rather next month.
Prior to previous recessions, the gap between these two rates has narrowed, thus every time the two get closer some investors prepare for the worst. But, according to Bank of America Merrill Lynch, we are not there yet.
"The yield curve may be flattening but our rates strategists do not expect it to invert in 2018," the research note Tuesday said.
An "inversion" of the yield curve takes place when lending in the short-term is perceived as more risky than lending in the long term. This means that investors believe the economy is doing much worse in the present than it will do in the future, i.e. we are in the middle of an economic slowdown.
"Given the average lag between inversion and recession is 27 months that would put a recession at the earliest in 2021," the strategists added, suggesting that it will take many months for sentiment to translate into the real economy.
"Of course history is only a guide and there continue to be risks care of possible trade wars and survey data," they also warned.
Bond yields have continued to creep higher this year on the back of unwinding stimulus packages from central banks and the belief that inflation is starting to pick up. Equities have also had the occasional rocky patch. The investment firm Brooks Macdonald said Tuesday it would be making changes to its equities portfolio with bond yields continue to trend higher.
Higher interest rates usually hurt the equity market because they represent higher costs for companies and thus less room for investment and dividends. Nonetheless, the investment firm is still more confident on the equity market rather than on the bond market.
"Equities should also benefit from robust earnings growth and technical support provided by share buyback activity," Brooks Macdonald said in a note.
"Overall we are marginally overweight equities as we continue to favor the asset class relative to fixed income, but we will look to shift our exposure within equity markets as higher yields have various implications for sectoral, geographic, quality and stylistic allocation decisions," Brooks Macdonald added.