In This Article:
* Rising risk premiums on corporate bonds may be omen
* Investors already wary of flattening yield curve
* U.S. economy seen strong, keeping default rates low
By Richard Leong
NEW YORK, July 16 (Reuters) - A reliable bond market indicator may be waving the flag that a U.S. recession is coming, market watchers said, and it is not the flattening yield curve.
Risk premiums on investment-grade corporate bonds over comparable Treasuries have been rising since February, approaching levels that are catching the attention of some fund managers and analysts.
"People are talking about the yield curve as a predicter of recessions. Credit spreads are the other element that's a pretty big tell," said Gene Tannuzzo, senior portfolio manager at Columbia Threadneedle Investments in Minneapolis.
With investors watching for signs of whether the end is near for the second longest U.S. expansion on record, this move in the $9 trillion corporate bond market bears watching.
The world's biggest economy still seems healthy by many measures: low unemployment, strong exports, a resilient housing market and sky-high consumer and business confidence.
Still, escalating global trade tensions have some investors worried. Also, U.S. inflation remains stubbornly low, removing pricing power from businesses, while benchmark interest rates are rising. Also, the federal deficit is ballooning after a massive tax cut revenues.
Some investors are nervous that the yield curve has flattened, with yields on long-term bonds getting close to those of short-term government debt. But the curve has not inverted, a situation when long-term yields go below those of short-term debt, seen as the most reliable recession indicator.
"We have had a weird recovery. If you have a weird recovery, you might have a weird recession," said Jim Paulsen, chief investment strategist at the Leuthold Group in Minneapolis.
Paulsen noted that risk premiums or spreads on Baa-rated corporate bonds over Treasuries increased to 2 percent this month based on data from Moody's Investors Services. This milestone was reached either during or just before six of the past seven U.S. recessions since 1970.
In February, spreads on the riskiest investment-grade bonds, based on Moody's rating scale, averaged 1.65 percent, the lowest in more than a decade.
Dallas Fed President Robert Kaplan told Reuters in an interview on Friday that while credit conditions are benign, they can deteriorate quickly.
"Credit spreads are reasonably tight, but that can change rapidly," he said.
POSSIBLE TROUBLE BREWING
U.S. corporations are sitting on about $2 trillion of cash and still can still borrow easily even as the Fed has been raising short-term interest rates since December 2015.