Central banks are cutting interest rates again, but recession is already knocking on the door

• The US Federal Reserve has cut interest rates for the first time in more than 10 years.
• The market correction that investors feared happened, but it wasn't particularly sharp.
• Due to deteriorating stock yields and interest rate cuts, the price of gold has shot up
• The main yield curve has inverted in the US and UK, everything now points to a global recession

The last few weeks have been particularly turbulent for the markets. We can’t help but start this month’s market commentary with the most important news – the Federal Reserve’s interest rate cut by 25 basis points to 2.25%. On the one hand, the US central bank’s decision is not surprising in the context of the trade war with China and the slowdown in GDP growth and inflation that has been observed since the beginning of the year. However, placed in another, longer-term context, the Fed’s decision is very surprising. While in the past the Fed tried to cut interest rates only when the US economy was already in recession (or on the brink), now for the first time a preventive measure is being taken – interest rates are being cut only due to a slowdown in growth, and even then not so significant (yet).

The US economic data is not yet so alarming – GDP rose by 2.1% on an annual basis in the second quarter, and inflation (a key indicator for monetary policy) has not fallen below 1.5% even in a month (at a target level of 2.0%). In fact, the US economy is performing relatively best of all developed Western economies of a similar size. However, the panic regarding the trade war, the pressure of President Trump and, above all, the fear of a recession on the scale of the one in 2008/2009 have seriously frightened the Federal Reserve. Moreover, analysts believe that this interest rate cut could be repeated in the near future if the trade war with China does not reach a conclusion soon.

Although market commentary traditionally focuses on what happened in the previous month, I can't help but pay attention to market developments in the first week and a half of August. Some very important things happened during this period. First of all – gold. Its price skyrocketed and reached $ 1,500 per ounce. This is certainly related to the weakening of the dollar as a consequence of the FED's decision to cut interest rates. If the FED continues to cut interest rates, we can expect gold to remain at its current levels or even continue to grow even more in the coming months.

To some, this huge jump in the price of the precious metal (from $1,344 on June 20) may seem strange given the fact that, despite the economic slowdown, there is no recession yet. However, it is wrong to think that gold and silver perform well during a recession; this is one of the more insidious myths associated with precious metals. They perform well during this period of the business cycle when equity yields are poor, but debt instruments such as government bonds also deteriorate as central banks lower interest rates. As we are currently seeing, this moment can occur before the onset of a recession itself, and historically, it has most often occurred towards the end of a recession and immediately after the start of a recovery. Due to this huge jump in the price of gold, of the investments we track in our Virtual Pension Fund, the "Permanent Portfolio", with a 25% allocation to the yellow metal, will most likely perform much better in August than the Universal Pension Funds, which have no investments in precious metals.

It is no coincidence that the huge jump in the price of gold occurred between August 1 and 7. Between July 30 and August 5, stock exchanges underwent a significant correction – the S&P500 in the US fell by 5.6%, which is a significant correction in just one week. From August 1 to 7, we witnessed a 5.6% drop in the German DAX, which is more related to the deterioration of activity in German industry than the decision of the Fed in the US. The English FTSE also fell by about 5.5% between August 1 and 6. All of these indices otherwise had a rather positive month of July and generally followed an upward trend. The stock markets are not the only ones that suffered. When it comes to lowering interest rates, this always has the most direct impact on debt instruments. As you can guess, immediately after the Fed's decision to lower interest rates, both short-term and longer-term US government securities went down.

But today (14.08) we have perhaps even hotter news– the main yield curve between 2-year and 10-year government bonds in the US has finally inverted. This is the surest indicator of an upcoming recession that we have. The inversion of the yield curve on government securities has preceded each of the recessions in the last 40 years by between 6 and 18 months. The yield curve has also inverted in the UK. If the lessons of history are correct, all this means that in 2020 the US economy will enter a recession. And if it enters a recession, the whole world will enter a recession too – the European Union is already on the brink anyway with the severe problems in German industry and complete stagnation in Italy.

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