The Treasury yield curve is an accurate predictor of impending recession.
The spread between the yield on the two-year and 10-year Treasury has been inverted since July. But according to the New York Fed, the relationship between the three-month and 10-year yields have the most predictive power for U.S. recessions.
In fact, an inversion has preceded every U.S. recession since 1950 (with only one “false” signal: the credit crunch and slowdown in 1967).
Recessions tend to follow inversion by four to six quarters.
The Federal Reserve controls the fed funds (overnight) rate which closely determines the 3-month rate. The 2 year rate, which is determined by the bond market, has been above the 10 year rate for months. Now that the Fed is finally raising the fed funds rate the 3 month is following higher. If the Fed raises rates another 1.25% by the end of 2022 as predicted the 10 YT - 3 month Treasury inversion will be strong.
While the 10 year Treasury yield is in a rising trend, it dropped fractionally for the past few days due to slowing of the real estate market. This indicates that the market still believes that the Fed will be able to bring inflation down to its target of 2% in the long term and also that the Fed will not use “extraordinary” means to suppress real yields to negative as they did between 2009 - 2022.
The inverted yield curve predicts a recession but it’s not clear whether this will be a mild “soft landing” or severe “hard landing” recession. It also doesn’t indicate whether the recession will durably suppress inflation or whether the Fed will cave in to pressure to drop rates, resulting in a 1970s-like prolonged stagflation.
@pauleckler check out the charts I attached to my OP. Inverted yield curve is pretty darn infallable as a precursor to recession with no false positives.
Wendy
Some beg to differ.
It sometimes takes years for a recession to hit following an inverted yield curve. And since recessions typically happen about every five years, an inverted yield curve “isn’t that different from a stopped clock that’s right twice a day,” Kiplinger noted.
No false positives?
Economists and other financial experts keep an eye on several different yield curves, but the 10-and-2 yield curve — the spread between the yield on the 10-year Treasury note and the yield on the two-year Treasury note — has been the best predictor of past recessions, Kiplinger reported. It cited Anu Gaggar, global investment strategist for Commonwealth Financial Network, who said the 10-and-2 yield curve has inverted 28 times since 1900, and in 22 of those instances, a recession has followed.
In fact, the yield curve inverted in March. Result: no recession. Yet.
In a recent column for the Official Monetary and Financial Institutions Forum, economist Julian Jacobs wrote that the yield curve inversion that took place in March was not necessarily an indication of a coming recession. He pointed out that yield curve inversions that last longer tend to have more predictive power. However, March’s yield curve inversion was quickly reversed.
For the record, I am predicting a recession next year, of what severity I have no idea. That depends on energy supplies, actions of the Fed, and a host of other unknowables. I find the yield curve inversion a “tell”, not necessarily a predictor.
The 10year-2 year went negative in July 2022 and is still negative. The long-term chart shows that typically this curve turns positive a few months before the recession starts. (Recessions are defined after the fact, not in real time.)
While it is still negative, the 10Y-2Y has just begun to turn up. It could be noise. I agree with you that a recession will probably start next year.
Everyone agrees a recession is likely. The Fed still hopes to avoid recession.
The tools they have are rather blunt, not highly focused. Most data they use is reported monthly. Yield data is some of the only real time data they have. You can understand the difficulty they have in getting interest rates exactly right.
Does the potential of a predictive objective measurement even matter when the decision to declare a recession is both subjective and holistic?
Can anyone elaborate how things change if in February of next year, the NBER declares we were in a recession in the first half of 2022 but it is now over
-OR-
In February of next year the NBER makes no declaration?
I feel like the topic of the “R word” is like a doctor asking us to tell them how much it hurts on a scale of 1 to 10. Is a 7 a recession or is 8? Doesn’t it hurt ANY LESS if I tell the doctor 7 instead of 8?
While the committee bases their pronouncement on past data, it is still subjective - and for what little we know, could end up being arbitrary especially in the case of a “shallow” recession (whatever that is!).
“Recession” is just a blanket word for a slower economy where many companies have lower earnings and tend to lay off workers so unemployment rises. In our capitalist economy, recessions have always been cyclical, though they vary in length and depth so it’s hard to predict how long recession and recovery will take.
Currently, the Coincident Indicators are still rising but the Leading Indicators are falling.
Timing stock purchases to the lowest point of a recession is one way to produce better long term gains.
Wendy