The fear of recessions strikes as the New Year approaches since most of the world economies as a recap have been jolted by Covid-19, then the Ukraine-Russia conflict; similarly, the worlds apex economy the United States of America has inverted its treasury yields, which looks that we may be headed for a recession.
To understand it more clearly, we’ll have to know some terms such as –“US Treasury, Yield of a Treasury, Yield Inversion and Yield Curve.’
Us Treasury
In a functioning economy, the most secure way of monetary transaction is ”Governmental Transaction”, the loans given to the government as the state will always be there and which does default in their debt to their debtors.
A government bond, it’s the instrument through which the government borrows money from the market. In the US they are known as treasuries, in the UK they are termed gilts and in India, they are called as G-secs.
Yield of Treasury
In a bank loan rate of interest varies with time, whereas a governmental bond comes with a pre-determined coupon payment, it means that the US government may ‘float’ an X-year time bond with $’x’ value and a coupon payment of ‘Y’$. It means, if you lend 100$ to the US government by buying a particular bond then you will get Y$ each year for a sum of ‘x’ years plus the whole sum which you have given, it would imply a yield of Y%.
But due to unforeseeable circumstances, if the bond is sold to another investor then the yield will change depending on which the bond price is sold, —- if the price increases to say, x+10$ per bond then the yield will fall because the annual return of Y$ remains the same, thus if the price falls then the yield will rise.
Yield Inversion
The yield curve has been a predictor of recession in the United States of America—- and according to the reports US treasuries are witnessing yield inversions for some time, the graph of 10 years to 3 months of treasuries has been turned negative.
Yield inversion occurs when yields of longer duration bonds are lower than the yields of shorter duration ones, for example, if an investor thinks that the economy might not do well, they will pull out money from short-term yield( such as stock markets) and place the money in long term bonds, resulting in the rise of long bonds and fall in their yields. The stated process leads to first the flattening of the curve and then eventually it leads to an inversion of the yield
Yield Curve
The duration at which the government borrows yields which may range from 1 month to 30 years. On average, for a longer duration of tenure, the yields are higher as one is lending money for a large span of time.
If these tenures of bonds are mapped then it will give rise to an upward-sloping curve, depending upon the steepness or flatness one can predict the value of money in the market, thus one can access the overall economic activity. If the investors feel they are at risk of losing money, then they pull out money from long-term bonds and put it in less risky assets such as stock markets. The result of a fall in long-term bonds will give rise to a yield rise, and the yield curve steepens.
What do we understand by the recession?
The term recession means the output of the economy contracting for at least two consecutive phases, along with job losses and a reduction in demand for overall goods. What constitutes a recession is determined by the Us National Bureau of Economic Research (NBER), on the basis of depth, duration and diffusion on the economy.
How does this matter to India?
With the rise of interest rates, the value of the Indian rupee will be weak against the dollar, thus Indian imports will be costlier and as a result, this can lead to severe inflation, domestically.
The recession may somehow benefit exports due to the weak rupee, but the demand for exports will witness a shortfall. Moreover, a silver line of the story can be that there can be low crude oil prices for the country.
