Every five years, the US economy experiences a recession. As a result, an inverted yield curve that forecasts recession three years in advance is similar to a stopped clock that is correct twice a day.
In other words, the median duration between the initial inversion of the yield curve and the commencement of a recession has been 18 months over the previous six decades, according to Brian Levitt, global market strategist at Invesco. Here are a few examples of why the curve isn’t very useful as a leading indicator:
- The next recession didn’t come until 1969, or 48 months after the yield curve inverted in 1965.
- In March 2001, the recession triggered by the burst of the IT boom began. The yield curve, on the other hand, had inverted 34 months earlier, in May 1998.
How many times has a recession been anticipated by an inverted yield curve?
An inverted yield curve is said to be a sign of impending recession. “The yield curve has reversed 28 times since 1900,” according to Gaggar, “and in 22 of these incidents, a recession has followed.”
What is the significance of an inverted yield curve as a recession predictor?
The yield curve is one of the most important predictors of economic downturns. This usually refers to the market for borrowing money from the US government by issuing bonds and other securities with maturities ranging from weeks to 30 years.
Each of these securities has its own yield (or interest rate), which varies in inverse proportion to the security’s market value – for example, when bonds trade at high prices, their yields are low, and vice versa. The yield curve is a chart that depicts the yields of securities at each maturity date in order to see how they relate to one another.
In normal times, investors demand greater rates of return for money they lend over a longer time horizon as a compensation for higher risk. The yield curve usually slopes upward to reflect this. When it slopes down, or inverts, it indicates that investors are more pessimistic about the long future than the near term: they believe a downturn or recession is imminent.
This is because they believe the Federal Reserve, the United States’ central bank, will decrease short-term interest rates in the future to help the economy recover (as opposed to raising rates to cool down an economy that is overheating).
The link between two-year and ten-year US Treasury debt is the most closely observed. The graphic below shows the so-called spread between these two indicators, with the grey areas representing recessions that have tended to follow shortly after.
As you can see, the yields on these two securities are approaching parity, and the trend indicates that the two-year will soon have a greater yield, indicating that the curve is inverting. The big question is whether an inverted yield curve signals an impending downturn. Certainly not. Please allow me to explain why.
Is a downward-sloping yield curve a sign of impending recession?
“On the surface, a downward-sloping yield curve just indicates that investors expect rate decreases but does not explain why.” Investors may be concerned about a recession and anticipate a rate cut from the Federal Reserve. Alternatively, they could be anticipating a rate drop by the Fed in reaction to lower inflation.
How long has it been since the yield curve inverted?
The last time the spread flipped was on August 30, 2019, according to Dow Jones Market Data data at 3 p.m. Traders are reacting to the likelihood that, in order to combat inflation, the Fed would need to deliver a larger-than-normal half-point rate hike, and potentially more, shortly.
Is the yield curve currently inverted?
The yield curve in the United States is not inverted now, but it has become much less steep in recent months. Today, the 10-year and 2-year US Treasury bond yields are separated by 42 basis points. The spread was treble that in March 2021. As a result, we could be on the verge of seeing an inverted yield curve, especially given how quickly the yield curve has flattened in 2021.
The yield curve inverts how often?
When the yield curve inverts, strategists argue that a recession is unlikely to occur because the economy typically contracts over a period of 12 to 24 months. In addition, recessions after curve inversions aren’t always certain.
What if the central bank used Operation Twist to reverse the inverted yield curve, which is a sign of impending recession?
Central banks can sell long-term bonds and buy short-term bonds, increasing long-term bond yields while decreasing short-term bond yields. In this approach, the inverted yield curve can be transformed into a normal-looking ascending slope, masking the true recession indicator.
What is the most likely cause of a yield curve inversion?
An inverted yield curve is most likely due to investors’ expectation of lower inflation.
When the yield curve inverts, what happens to stocks?
After an inversion, stocks really do rather well. This is especially true when the yield curve inverts. Between the first incidence of an inverted yield curve and the market high that precedes every recession-induced drop in equities, the market has historically performed well.