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Bond quality spread confirming looming economic slowdown

A Wall Street veteran is going against the market consensus by sharpening his economic slowdown call.

The Economic Cycle Research Institute's Lakshman Achuthan is citing troublesome activity brewing in the quality spread between junk bonds and corporate debt. It's suggesting default risks are rising — an ominous signal for the stock market.

Achuthan's charts show the difference between junk bond yields and the rate on quality-rated corporate debt. He then inverts that chart so it gives a clear picture of what's to come: When the junk-quality spread widens, the line points down, warning of greater economic risk ahead.

"It's been widening since spring," he said Monday on CNBC's "Trading Nation." "It's accelerated a little bit here."

Achuthan, a business cycle expert and the institute's chief operations officer, has been attacking Wall Street for being too optimistic about 2018. He's been warning corporate clients and fund managers that it could cause another downdraft in an easily spooked market.

"That's showing a signal from a very liquid, very smart bond market keying off of some concern about relatively higher default risk as the economy slows. This happens every time we have a slowdown, and it's corroborating what we picked up in our leading indexes," he added.

Achuthan believes the downturn could last a couple of quarters and affect U.S. and global markets. He says it could materialize before the second half the year begins.

"It'll be alarming I think in the sense that it's the opposite direction that everybody is expecting," Achuthan said. "On this chart, each of those troughs, those are the bottoms and the slowdowns. We've had three slowdowns since the recession."

Is Wall Street too optimistic?

Not all firms share Achuthan's forecast. Just this week, Nomura boosted its 2018 GDP expectations to 3 percent from 2.7 percent — citing the benefits of current fiscal policy. According the CNBC's latest Fed Survey, the Wall Street consensus is 2.9 percent.

But Achuthan doesn't see fiscal policy, particularly tax cuts, moving the needle.

"Let's say we get a boost from the tax cut this year, it's probably on the order of half percent positive boost to economic growth," Achuthan said. "If you are looking at a slowdown of a couple percent, it's not enough to offset it."

The latest GDP reading is 2.6 percent for 2017's fourth quarter. So, a 2 percent hit would slice growth to a fraction.

It may not be an encouraging statistic, but Achuthan isn't predicting a full-blown collapse.

"There's no recession in sight. But everybody is kind of extrapolating the strength, the momentum — to use a word that's out there from 2017 into 2018. You've got the tax cuts on top so 'it must be good' – but actually the cycle itself seems to be decelerating this year," Achuthan said.


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