The yield curve shows the interest rates, which buyers of government debt products demand to lend their money over various periods, whether overnight, for one year, ten years or more. The yield curve is usually upward-sloping, whereby higher fixed rates of return are earned from lending money for more extended periods of time. This is the cost of waiting and the additional risk borne by lenders. Shorter-term yields reflect what investors believe would happen to central bank policies in the near future. Longer-dated maturities represent investors' best guess where inflation, jobs, growth rates and interest rates are heading over the medium to long term. The yield curve's slope, the so-called yield "spread", is a fair predictor of future economic growth.

What Does It Mean to Have An Inverted Yield Curve?

An inverted yield curve means that long-term interest rates are lower than shorter term. With an inverted yield curve, yield decreases the longer the maturity date is. In that case, people are discounting the present time with higher rates than they discount the future. This can also be seen in the derivatives markets when some future contracts are traded more twisted than they should be in normal cases. As of October 13 2022, the majority of the futures market was forecasting the US federal bank would increase interest rates by an additional 175 bps by February 2023, according to the Chicago Mercantile Exchange FedWatch Tool, which measures investor sentiment in the Fed funds futures market, nearly 40% of the market expects the Fed to hike the federal funds rate to above 5%, a level it has not been seen since 2007.

If short-term interest rates exceed longer-term rates, then it is irrational to lend for the long term. Instead, banks, and other financial intermediaries, will achieve better returns by making short-term investments. That should cause overall investments to decline; because many projects require long-term funding, and those may get cut or get out of business. That, in turn, can reduce growth rates. On the back of the Covid-19 crisis, the Ukrainian-Russian war, China's lockdown and the US tightening overshoot… The global new normal is something unique. It is over-saturated with intensive risks and tends to tolerate what were historically intolerable levels of risk exposure. This might give hope in future for high-risk profile investments.

Global and MENA Yield Curves Sloping Downward

The global scene is highly affected by the US economy. The US Treasury curve steepened as companies started selling bonds with longer maturities. The global yield curve is not an exception; its inversion comes as bonds enjoy a rebound rally on forecasts that a slowing economy will eventually force governments to slow or even halt rate hikes. The Global Aggregate index has gained 5% in November 2022, heading for its most significant monthly return since the global crisis in 2008. Global bonds, along with US peers, are signalling a recession, with a gauge measuring the worldwide yield curve inverting for the first time in at least two decades. A recession that was anticipated to be short-termed, as mentioned in an earlier article.

According to Bloomberg Global Aggregate bond sub-indexes, the average yield on sovereign debt maturing in 10 years or more has fallen below that of securities maturing in one-to-three years. That has never happened before since the beginning of the millennium. Key drivers for inverted yield curves shall be central banks' tightening policies, motivated by hyperinflation fears and their persistence to keep anchoring cash rates.

Inverted yield curves can be seen clearly across the MENA region countries. In Bahrain, a bond maturing in 9 months yields 6.1 %, whereas the five years maturing bond pays only 5.8 %. The Egyptian nine months yield is 20.67 %, whereas the five years yield is 19.4 % and the ten years is 18.9 %. In Jordon, a bond maturing in 6 months pays a yield of 6.26 %, whereas the bond maturing in 5 years pays only a 4.57 % yield to creditors. Qatar is not an exception, as it pays a 5.27% yield on two years maturing bonds and only 4.9 % on 4.2 on bonds maturing in 10 years. 

This is one signal for a potential slowdown, but it is pretty alarming when it comes to the current global context and the semi-consensus on a difficult couple of years to come, including the year 2023. Most analysts argue that an inverted yield curve implies a coming recession within 12-18 months. That's a far better catalyst than many forecasting tools, but still indefinite. One can argue that inverted yield curves in emerging markets are not new and are not necessarily related to recession forecasts. 

More Interest Rates Hikes in the Pipeline

European Central Bank President Christine Lagarde and four other Federal Reserve officials have lately signalled more rate hikes, as Germany may already be in a recession ahead of the US. A US recession tends to follow a year after the curve inverts; this is what history tells us. A rise in government bond yields can have a negative effect on commercial bank balance sheets. However, the full impact depends on the size, structure and maturity of total bank balance sheets and the extent of hedging in a specific macroeconomic scenario.

MENA region countries are vulnerable to spillovers from sharply higher policy rates in the United States and other advanced economies. These can lead to higher bond yields and sovereign risk spreads in the region, alongside capital outflows and currency depreciation, which can turn into dollar-denominated external debt crises. In addition, higher import prices will worsen inflation. In this context, the risks to the MENA region from the global monetary tightening can be mitigated by a range of tools, including enhanced communication among central banks to mitigate financial stability risks, monitoring cross-border spillovers, and increased support from international financial institutions.

The vulnerability of many of the region's economies, particularly the oil importers, to external financial pressures that could arise from capital outflows has increased due to widening current account deficits and deteriorating foreign exchange reserves. Suppose sentiment continues to worsen, or global interest rates rise further than assumed, driven by persistent inflation. In that case, oil importers could face even more adverse credit conditions as they seek to finance growing deficits. This could lead to severe difficulties in meeting food and energy needs and servicing external debt. High government debt in several economies (like Djibouti, Egypt, Jordan, Lebanon, Morocco, and Tunisia) further complicates the outlook. Sovereign risk spreads have widened in several economies in recent years, reflecting more uncertainties and a higher probability of default.

Risk Mitigation Possibilities for Poor and Critically Indebted Markets

According to the World Bank flagship report, minimizing the probability of crisis will require a sound macroeconomic policy mix, where the fiscal policy does not add to inflationary pressures and prompts additional monetary policy tightening. This risk can be mitigated by ensuring that fiscal support is carefully targeted toward the poor. Above all, macroeconomic authorities need to avoid tightening policy uncertainty, which could add further pressure to global financial markets, already threatened by rising borrowing costs and generate additional adverse spillovers to growth. In a gloomy context of rising borrowing costs, slower growth rates, and inverted yield curves, the international community needs to boost efforts to reduce debt distress and ease the risk of debt crises in emerging markets. The G20 members can help countries overcome debt restructuring challenges resulting from the unaffordable debt owed to a diverse set of creditors. Decisive debt restructuring at an early stage can help avoid the lengthy and costly adjustment process that sometimes accompanies more exhausting efforts and can result in more favourable outcomes for both borrowers and lenders.

Economic Performance in the MENA region Within the New Global Context

The rebound in the MENA region's output in 2022 by an estimated 5.7 %(the highest in a decade) was totally attributed to oil exporting countries, which managed to enjoy windfalls from increased oil and gas prices and rising production. Nevertheless, the region is still characterized by divergent economic conditions and growth trends, high levels of poverty and unemployment, low labour productivity, elevated vulnerabilities, and fragile social conditions in many countries. 

Rising inflation and tightening financing conditions impacted consumer spending, which stagnated across the region in the first half of the year 2022. MENA's oil-importing economies have been badly affected by the growth slowdown in the European Union, the destination for almost half of their goods exports in 2021 and accounting for about 7.4% of GDP. Egypt's output slowed down significantly in the first half of 2022. Morocco's economy also deteriorated sharply in the first half of 2022 due to the drought and rising energy prices, partially compensated by a recovery of services boosted by the tourism sector. Growth projections for the MENA region are revisited to have a declining slope from 5.7 % last year to 3.5 % in 2023 to 2.7 % in 2024. 

Inflation records have also diverged between oil exporters and importers. In Egypt, basic inflation reached 24.4% on an annual basis in December, well above the unrealistic target band of 5-9%. Inflation in Morocco in last November reached over 8%, its highest level since the 1990s. In contrast, inflation in the GCC economies remained lower than the global average, benefiting from fixed exchange rates and fuel subsidies. In KSA, consumer prices rose by 2.9%. However, there were significant variations among oil exporters, with inflation at 52% in Iran and 8.1% in Algeria.

Contradicting Signals of a Recession and a Rebound

Although an inverted yield curve gives a clear signal for a recession or –at least an economic slowdown, there is evidence of contradicting signals in the United States economy. An improving housing market (lower rates), a rebound in bank lending, a tight labour market, higher oil prices and well-behaved credit markets. All these point to a stable US economic outlook. MENA countries with a US-pegged and semi-pegged exchange rates regimes are vulnerable to these developments, so it is essential to get a better understanding of the US Economic dynamics to improve insights into these countries' economies.