Yardstick On US Economy Shows Recession Fears Rising

Authored by Ven Ram, Bloomberg cross-asset strategist,

A powerful indicator of economic risk is on an uptrend, suggesting that investors are preparing for a recession in the US.

The ratio between gold and oil has surged to almost 24 from average levels of around 17 that have prevailed since the start of the millennium. Gains in bullion tend to far outstrip increases in oil prices during the onset of a recession. That’s because investors position themselves for the Federal Reserve to cut interest rates, after a long period of expansion when they would have been typically focused on the inflationary impulse stemming from higher energy prices.

The ratio between gold and oil adds to a dashboard of metrics that investors can use to adjudge, in real time, where in the economic cycle we are. Last month, the spread between high-yield dollar-denominated corporate bonds and those on investment-grade securities widened to levels that have been sufficient to trigger a recession in the past.

The Fed is approaching the end of its tightening cycle, with a likely 25-basis point increase next month, putting its benchmark rate on a par with the terminal rate indicated in its dot plot. Interest-rate traders are now factoring in rate cuts of about 50 basis points by the end of the year.

That speculation has spurred gold, which has risen almost 10% so far this year, outpacing gains of 7% for the S&P 500 and about 3% for the Bloomberg Treasury Index.

On display is gold’s convexity, a property that bestows outsized gains when interest rates ebb lower and diminished losses when yields head higher. A study in 2020 showed that bullion has a duration of 20 when interest rates fall. On the flip side, the Fed’s most ambitious policy tightening in decades last year showed the empirical duration of gold to higher rates was just above three years.

Crude-oil prices have risen some 5% this month after OPEC+ unveiled a surprise production cut of more than 1 million barrels a day, though it’s far from clear if the increase will be sustainable beyond the here and now.

While gold versus oil has been an extremely useful barometer for investors reading the tea leaves on the US economy, there was a period from late 2014 to early 2016 when the ratio was elevated without a recession being triggered. However, it should be noted that the surge in the ratio then came on the back of sliding oil prices, unlike the case now.

All told, investors would do well to pay heed to the signals coming from the commodities complex as well as the credit markets as we approach an inflection point in the US economy.