Gundlach Sees Recession Risk Rising Based on This Indicator

  • Jeffrey Gundlach puts the odds of a recession happening before the 2020 US presidential election at 75%.
  • In June, he put the recession risk odds at 65% within a year, which was higher than his estimation of 50% odds in May.
  • He’s assessing the recession risk mainly based on the current shape of the yield curve.

Inversion of the yield curve

As the trade war rages on, many market observers worry about an upcoming slowdown or an outright recession. One especially potent signal investors usually keep an eye on is the inversion of the yield curve. When the yields of shorter-duration securities become larger than those of longer-term securities, the yield curve is said to be inverted. The narrowing of the spread implies that investors are worried that future short-term rates will be lower than current rates. This, in turn, could imply an economic slowdown.

Bond yields sinking and spread declining

Investors across the world are scrambling to get into safe-haven bond markets, leading to plunging bond yields. A classic recession indicator is the spread between the US ten-year Treasury bond (IEF) and the two-year Treasury security (TLT). The yield on the ten-year bond has declined 40 basis points in the last month. This has narrowed the ten-year–two-year spread to just 13 basis points. An inversion of this part of the yield curve is considered a very strong signal of an upcoming recession.

Gundlach: Odds of recession at 75% before 2020 US election

Speaking with Yahoo Finance on August 6, “Bond King” Jeffrey Gundlach mentioned that recession odds were rising for the US economy. He’s now putting the odds of a recession happening before the 2020 US presidential election at 75%. During DoubleLine’s investor webcast on June 13, Gundlach put the odds of the US sliding into a recession at 65% within a year. In May, he put the probability of a recession in the next year at 50%.

Gundlach: Yield curve signaling increased recession risk

The main reason Gundlach sees increasing odds of a recession is the condition of the yield curve. He mentioned to Yahoo Finance that one market indicator that’s “full-on recessionary” right now is the yield curve. He thinks that it looks “a lot like 2007.” He made his worry about the economy and markets quite clear, saying, “There’s no way to sugar coat it.”

Fed to realize it’s behind the curve

Investors should note that even if the yield curve starts to steepen a bit, that’s not necessarily a good sign, according to Gundlach. He said, “That would almost seal the fate of recession coming.” Why? Because after inversion, when the curve starts steepening again, it implies that the Fed has realized it’s behind the curve. The market is also aware of this and knows that the Fed will be reducing rates to play catchup.

Other leading economic indicators and recession risk

Gundlach also sees signs of corroboration from other leading economic indicators, such as weakening purchasing managers’ indexes, worsening sentiment surveys, and deteriorating future consumer expectations.

Worsening economic conditions and uncertainty surrounding the trade war are the reasons investors are piling into bonds. The development has led to a steep rise in negative-yielding debt. This is why Gundlach sees huge potential in gold going forward. Gold’s price performance so far this year is now better than that of the markets. While the SPDR Gold Shares ETF (GLD) has returned 16.3% as of August 7, the S&P 500 (SPY) has returned 15.2%.

Bank of America and Morgan Stanley also worry about a recession

Gundlach isn’t the only one that’s worried about a recession. Bank of America economists have warned investors that there are significant downside risks to US and global growth. Morgan Stanley also predicts that if the US levies 25% duties on all Chinese goods and China hits back, there’s a high likelihood of a global economic contraction within the next three quarters.