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BIS Tells Recession Hunters It Can Top the Yield Curve Indicator

BIS Tells Recession Hunters It Can Top the Yield Curve Indicator

(Bloomberg) -- The search is on for clues to the next recession and the Bank for International Settlements reckons it’s got a good one.

Sticking with the themes of risk, leverage and asset prices that have long obsessed the Basel-based institution, the BIS took a look at financial cycles. Based on its analysis, in a piece co-written by Chief Economist Claudio Borio, it says this is a better recession-risk indicator than the term spread out to three years.

BIS Tells Recession Hunters It Can Top the Yield Curve Indicator

The paper, in the BIS Quarterly Review, doesn’t offer an insight into what’s currently going on in the global economy, but its publication is timely.

With the current U.S. expansion mere months away from becoming the longest in postwar history, and some indicators weakening, economists are trying to figure out how bad it could get in 2019. An inversion in part of the yield curve has sparked talk of recession risk, and Pimco said on Friday that signals are “flashing orange.”

But the BIS says that financial cycle proxies “generally outperform the term spread” in its analysis:

“Given that financial cycles build up slowly, the corresponding proxies provide information about recession risk even at a three-year horizon. And when we run a horse race against the term spread -- the indicator most widely used to assess recession risk -- we find that they outperform the term spread.”

The latest BIS work is very much in line with its tone when it comes to monetary policy and risks. Given the often rapid build up of credit, leverage and asset prices in recent decades, it’s long warned that central banks have kept policy too loose for too long, overly focusing on inflation and paying insufficient attention to imbalances.

“Even if inflation did not raise its ugly head, a downturn could take place,” Borio said. “In fact, since the early 1980s economic downturns have been triggered more by financial booms gone wrong than by monetary policy tightening to quell inflation flare-ups.”

To contact the reporter on this story: Fergal O'Brien in Zurich at fobrien@bloomberg.net

To contact the editors responsible for this story: Fergal O'Brien at fobrien@bloomberg.net, Alister Bull

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