Tough Economic Times Ahead and They Are Priced In

Make no mistake about it; there are tough economic times ahead. The credit markets seem to have priced in, if not the worst case, then at least a very realistic case. Consider Chart 1 in which we have plotted the spread between the yield on a Baa corporate bond and the yield on a 10-year Treasury security.

Make no mistake about it; there are tough economic times ahead. The credit markets seem to have priced in, if not the worst case, then at least a very realistic case. Consider Chart 1 in which we have plotted the spread between the yield on a Baa corporate bond and the yield on a 10-year Treasury security. The wider the positive spread, the greater the default risk assumed by the market. In the week ended October 24, this spread shot up to a record high 5.55 percentage points. The previous record high for this series, which began in January 1962, was 3.96 percentage points reached in the week ended November 5, 1982. You may recall that the early 1980s were tough economic times with two economic recessions occurring in the first two years of the decade.

 

When the economists at the National Bureau of Economic Research get around to it, we think they will date the beginning of the current recession as either the fourth quarter of last year or the first quarter of this year. This is what the Federal Reserve Bank of Chicago’s National Activity Index (NAI) suggests. This is a weighted index of 85 economic variables that appears to be an excellent coincident indicator. Historically, when the 3-month moving average or quarterly average of the NAI has dropped below minus 0.70, a recession has occurred (see Chart 2). The series starts in 1967. In its history, this minus 0.70 rule for the NAI has given only one false recession signal – the fourth quarter of 1991. Chart 3 shows that the quarterly average of the NAI slipped marginally below minus 0.70 (minus 0.76, to be exact) in the fourth quarter of 2007.

 

Full Report

Northern Trust is a global leader in delivering innovative investment management, asset and fund administration, fiduciary and banking solutions to corporations, institutions and affluent individuals. For nearly 120 years, we have evolved with the changing needs of our clients and our world.