Bond market is priced for recession (Mar-08)

While much has been made of the recent rise in the markets’ inflation expectations, less attention has fallen on just how pessimistic the markets have become on the outlook for activity. Indeed, the fall in 2 year real gilt yields to just 0.3% suggests that the bond market is priced for a recession. In contrast, most economists (ourselves included) are forecasting GDP growth this year just shy of 2%. Safe haven flows undoubtedly explain some of the disparity. Nonetheless, it is hard to believe that the divergence between the bond market and the economic fundamentals can last forever. Either the outlook for the economy will deteriorate markedly or bond yields will eventually rise again.