What will a US recession do to the dollar?

A notable movement in the US interest rate market has very often signaled a recession in the past. If the United States economy actually takes a hit, it could rumble strongly against the dollar.

It is impossible to see into the future. But it's pretty creepy to see how accurately the bond market can predict whether a recession is coming in the United States. Once 70-year Treasury yields dip below two-year bond yields, things don't look good for the US economy. Since the 6s, the bond market has given such a signal eight times. And each time, the United States economy went into recession 24 to XNUMX months later. Coupled with worrying news about rising energy prices and skyrocketing inflation, it's no wonder some people are concerned about the US economy.

Recession signal does not apply to the Netherlands
A recession in the United States could put the dollar under pressure. An economic downturn often triggers one or more interest rate cuts at a central bank. The US Federal Reserve has more room for this than the ECB. That difference will only widen if interest rates in the United States rise further this year as expected in response to high inflation. Incidentally, the Dutch interest rate market is not pointing to a recession for the time being. The yield for two-year government bonds (0,09%) is significantly lower than that for ten-year bonds (0,86%). Moreover, the difference has increased slightly in recent months. A similar pattern is emerging in Germany's economic superpower.

Big difference from previous recession signals
The dollar has already taken a step back in recent days. Are traders already positioning themselves for a possible recession? In reality, the recent dollar pressures are primarily caused by what is happening in Ukraine. Russia's promise to withdraw reduces the likelihood of a major escalation of the battle. As a result, safe-haven currencies – such as the dollar – are less popular. Moreover, it is not yet certain that there will be a recession. The two- and ten-year yields are close to each other, but have not yet been definitively crossed. A very big difference with the run-up to previous recessions is that longer-term interest rates have risen considerably in recent months. There are two reasons for this.

Interest rates were artificially low
First, rising interest rates are an indication that investors' inflation and growth expectations have increased in recent times. In addition, the US central bank has phased out the support measures that were introduced during the corona pandemic. In recent years, long-term interest rates have been artificially pushed down by such measures. There is a good chance that the XNUMX-year yield would now be a lot higher if no action had been taken. In that case, there would now be a lot less attention for the recession risk. For now, in any case, it is far too early for real concerns about the US economy and the dollar's slide that this would set in motion.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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