Why Nifty bulls must buckle up for the next big fall
Federal Reserve cut the interest rates by 25 basis points from 4.75% to 4.5%. This move had served as a key trigger for the market decline of 2.85% in S&P 500. Such a sharp fall in the index sent chills down investors’ spine. Most are wondering whether there is more pain in the offing.
Unfortunately, the answer is yes. Let’s see why I am saying this.
Whenever there are instances of rise in inflation, the Federal Reserve hikes interest rates to combat it. This increase in rates primarily affects short-term rates which is reflected in the higher 3 month bond yields. Such a prolonged continuation of rate hike sometimes pushes the long term US 10-year government bonds yields lower.
The long term yields are market dependent and Fed has limited control over it. This phenomenon of higher short-term and lower long-term yields leads to yield curve inversion. This is basically the market's way of saying that a slowdown in the economy is required to control the rising inflation.
The probability of the economy to hit a recession increases when the yield curve remains inverted for a longer period of time. Historically, as shown in the chart below, every instance where the curve dipped below the zero/black line and then rose above it has been followed by a recession.
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