Markets are failing to price in the ‘worryingly high’ risk of global recession and a ‘slowdown’ in the next three months, according to Allianz bond manager Mike Riddell.
Riddell believes a number of short and longer-term indicators are pointing to a slowdown in economic growth but said the markets are ‘ignorant of the potential risks’ and underestimating the potential for a recession.
He pointed out that 2018 started with volatility at record lows and despite choppier stock markets so far this year, the risk was still not being priced in.
One of the major risks, and one that could have the most immediate impact, is a slowdown in the Chinese economy which would have serious repercussions for other markets, particularly the eurozone.
Riddell, who manages the £1.6 billion Allianz Gilt Yield £72 million Allianz Index-Linked Gilt and £56 million Allianz Strategic Bond funds, said China had been ‘slowing sharply’ over the past nine months, with the potential to ‘destabilise markets’.
He said China’s slowdown wasn't on the verge of creating another financial crisis but ‘the markets are not reflecting what we think will be a reasonable slowdown in three-to-six months’.
‘Markets are going to get very worried before they get happier,’ he said.
Looking further out and the picture is only getting worse, with a number of ‘leading indicators’ pointing towards recession, not least the US yield curve.
When the yield curve inverts – meaning yields on shorter term bonds are higher than those on longer term bonds – this is an indicator that recession is on the way.
‘The curve in the US is now almost completely flat,’ said Riddell. ‘It is not inverted yet but it you look at the measure of the two-10s curve – the difference in yield in a two-year treasury and a 10-year treasury – you can see the curve is almost completely flat but in 2020 there are signs of inversion.’
The yield curve is ‘telling you there is a risk of something going wrong in the next 12-to-18 months, but other markets are not awake to this risk’ said Riddell.
He added that corporate bond spreads – the difference in yield between corporate bonds and government bond yields – showed that the ‘bond markets specifically and the financial markets more generally’ are not pricing in a ‘worryingly high’ risk of recession.
Adding fuel to Riddell’s (pictured) recessionary concerns is a slowdown in global ‘money supply growth’, essentially the amount of money that people have to spend.
This slowdown has been exacerbated by a pick-up in inflation, and Riddell said it suggested ‘global growth is set to start weakening and this has further to go’.
‘We are expecting global economic activity to weaken from what is a fairly decent level over the next six months, and that is not priced into financial markets,’ he said.
Riddell warned of a further threat from rising interest rates. He pointed to a 'credit bubble', with leverage ratios for US non-financial companies the highest they have ever been.
‘Lots of this debt will become vulnerable to high interest rates,’ said Riddell. ‘Suddenly money you were borrowing two years ago at 1% to 2% you are now refinancing at 5%, 6% or even 7%. You will find a lot of people getting into trouble.
‘The market is not pricing in this risk… the vulnerability to higher rate debt is huge.’