BlackRock Strategist Says Yield Curve Is Losing Predictive Power

(Bloomberg) -- An inverted yield curve has lost its ability to predict a recession in the current environment of low interest rates, according to a senior macro strategist at BlackRock Inc.

“There are many technical factors,” Gargi Chaudhuri, 40, said in an interview at her New York office. One could be that the market just sees little inflation risk, and isn't building in an inflation premium into longer maturities, she said.

A drop in longer-term bond yields below short-end rates, known as inversion, has historically been seen as harbinger of recession, and both the U.S. and Canadian markets have seen this occur in parts of the curve in recent months.

The gap between 3-month and 10-year U.S. rates went negative in March. Though it has returned to positive territory, it remains close to flat amid subdued inflation expectations. A similar measure for Canada is also just a few basis points above zero after recovering from an inversion that first took place in March.

A lack of inflation has been a key issue globally, with the International Monetary Fund projecting a 1.6 percent inflation rate for advanced economies in 2019, compared with 3.2 percent in 2011, the high mark in this decade. Federal Reserve Chairman Jerome Powell has said that low inflation readings are “transitory,” though many in the market remain unconvinced and the U.S. will get its next reading on consumer price inflation this Friday.

‘Modest Rebound'

Instead of a looming recession, BlackRock expects the global economy to start improving as trade tensions recede and that feeds into business decisions, Chaudhuri, who is also head of fixed-income strategy for Canada, said in an interview last week. Also, central banks are expected to remain “accommodative,” she said.

“A modest rebound in global growth still remains our base case” said Chaudhuri by email Monday after President Donald Trump threatened over the weekend to boost tariffs with China, reversing optimism at the start of the year.

Further comments from U.S. Trade Representative Robert Lighthizer, who accused China of backpedaling on commitments during negotiations, sent investors piling into Treasuries late in New York trading on Monday, though China's top trade negotiator still plans to travel to the U.S. this week for talks and government bond markets steadied Tuesday.

‘Tail Risk'

Still, there is “an increasing tail risk if the global trade tensions worsen meaningfully from here,” Chaudhuri said.

The turning point for Canada could take a bit longer, she said in the interview. The C$2.2 trillion ($1.6 trillion) economy is likely to bottom in the second half of the year, said Chaudhuri, who joined BlackRock in 2010 from Jefferies, where she ran the U.S. inflation trading desk.

Oil prices, which were a drag on Canadian gross domestic product last year, have risen almost 35 percent this year and the discount between domestic and U.S. prices is about one quarter of the levels seen in October.

Despite the Canadian energy sector going through some structural shifts “We are going to see some of that recovery,” in prices reverberating through the wider economy, she said. Chaudhuri expects Canada's economy to grow by 1.25 percent to 1.5 percent in 2019, although she doesn't expect the Bank of Canada to hike rates any time soon.

--With assistance from Theophilos Argitis and Erik Hertzberg.

To contact the reporter on this story: Esteban Duarte in Toronto at eduarterubia@bloomberg.net

To contact the editors responsible for this story: Christopher DeReza at cdereza1@bloomberg.net, ;David Scanlan at dscanlan@bloomberg.net, ;Benjamin Purvis at bpurvis@bloomberg.net, Jacqueline Thorpe